Download Forecasting - Rajeev Dhawan

Lecture 4: Basics Of Macroeconomics I
Dr. Rajeev Dhawan
Director
Given to the
EMBA 8400 Class
Buckhead Center
April 3, 2010
Article: Business Cycles
BUSINESS CYCLE
REFERENCE DATES
Peak
DURATION IN MONTHS
Trough
Quarterly dates
are in parentheses
Contraction
Expansion
Cycle
Peak
to
Trough
Previous
trough
to
this peak
Trough
from
Previous
Trough
Peak from
Previous
Peak
May 1937(II)
February 1945(I)
November 1948(IV)
July 1953(II)
August 1957(III)
June 1938 (II)
October 1945 (IV)
October 1949 (IV)
May 1954 (II)
April 1958 (II)
13
8
11
10
8
50
80
37
45
39
63
88
48
55
47
93
93
45
56
49
April 1960(II)
December 1969(IV)
November 1973(IV)
January 1980(I)
July 1981(III)
February 1961 (I)
November 1970 (IV)
March 1975 (I)
July 1980 (III)
November 1982 (IV)
10
11
16
6
16
24
106
36
58
12
34
117
52
64
28
32
116
47
74
18
July 1990(III)
March 1991(I)
8
92
100
108
March 2001 (I)
November 2001 (IV)
8
120
128
128
NBER Report Cycle Dates 2003
Mar 01’ ~ Nov 01’
9
-0.1%
Forecast of the Nation, 2003
-4.0%
4.2
5.6
Real GDP and Business Cycles
(Bil. 2000$)
12000
10000
8000
6000
4000
2000
0
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
Real GDP and Business Cycles
(Bil. 2000$)
11000
10000
9000
8000
7000
6000
1988
1990
1992
1994
1996
1998
2000
2002
2004
Industrial Production and Employment
(Index: 1997=100)
118
(Mil.)
134
116
132
114
112
130
110
128
108
106
126
104
102
1998
1999
2000
2001
Industrial Production
2002
2003
2004
124
2005
Total Payroll Employment
Retail Sales
(Bil.)
320
310
300
290
280
270
260
250
AUG DEC APR AUG DEC APR AUG DEC APR AUG DEC APR AUG DEC
2000
2001
2002
2003
2004
Real Disposable Income Growth
On a Percent Change from a Year Ago Basis
(%)
6
5
4
3
2
1
0
JUL NOV MAR JUL NOV MAR JUL NOV MAR JUL NOV MAR JUL NOV MAR JUL NOV
1999
2000
2001
2002
2003
2004
Real Retail Sales Growth
On a Percent Change from a Year Ago Basis
(%)
8
6
4
2
0
-2
-4
-6
JUL NOV MAR JUL NOV MAR JUL NOV MAR JUL NOV MAR JUL NOV
2000
2001
2002
2003
2004
Article: NBER’s FAQs
Q: The financial press often states the definition of a recession as
two consecutive quarters of decline in real GDP. How does that
relate to the NBER's recession dating procedure?
– Most of the recessions identified by our procedures consist of two
or more quarters of declining real GDP, but not all of them
– We consider the depth as well as the duration of the decline in
economic activity.
– Second, we use a broader array of indicators than just real GDP
– Third, we use monthly indicators to arrive at a monthly chronology
Q: Could you give an example illustrating this point?
– The two-quarter-decline rule of thumb would not have allowed the
declaration of the recession until August 2002
Q: How does the NBER balance the differing behavior of
employment and output?
– There is no fixed rule for how the different indicators are weighted
Article: NBER’s FAQs
Q. You emphasize the payroll survey as a source for data on
economy-wide employment. What about the household survey?
– Although the household survey is a large, well-designed
probability sample of the U.S. population, its estimates of total
employment appear to be noisier than those from the payroll
survey
Q. How do the movements of unemployment claims inform the
Bureau's thinking?
– A bulge in jobless claims would appear to forecast declining
employment, but we do not use forecasts and the claims numbers
have a lot of noise
Q: What about the unemployment rate?
– Unemployment is generally a lagging indicator. Its rise from a very
low level to date is consistent with the employment data
Peak & Trough Announcements
The November 2001 trough was announced July 17, 2003.
The March 2001 peak was announced November 26, 2001.
The March 1991 trough was announced December 22, 1992.
The July 1990 peak was announced April 25, 1991.
The November 1982 trough was announced July 8, 1983.
The July 1981 peak was announced January 6, 1982.
The July 1980 trough was announced July 8, 1981.
The January 1980 peak was announced June 3, 1980.
2001 Recession vs. History
For Details Refer:
http://www.nber.org/
Real GDP and Consumption
FRBSF Economic Letter, June 2003
Investment and Stock Market
FRBSF Economic Letter, June 2003
Chapter 24
Measuring the Cost of Living
Consumer Price Index & Inflation
 Inflation refers to a situation in which the
economy’s overall price level is rising.
 The inflation rate is the percentage change in the
price level from the previous period.
 The Consumer Price Index (CPI) is a measure of
the overall cost of goods and services bought by a
typical consumer (produced by BLS).
 Inflation rate is change in CPI.
Steps to Calculate CPI Index
 Fix the Basket: Determine what prices are most important
to the typical consumer.
– The Bureau of Labor Statistics (BLS) identifies a market basket of
goods and services the typical consumer buys.
– The BLS conducts monthly consumer surveys to set the weights
for the prices of those goods and services.
 Find the Prices: Find the prices of each of the goods and
services in the basket for each point in time.
 Compute the Basket's Cost: Use the data on prices to
calculate the cost of the basket of goods and services at
different times.
 Choose a Base Year and Compute the Index:
Steps to Calculate CPI Index
Choose a Base Year and Compute the
Index:
– Designate one year as the base year, making it
the benchmark against which other years are
compared.
– Compute the index by dividing the price of the
basket in one year by the price in the base year
and multiplying by 100.
How the Inflation Rate Is
Calculated
The Inflation Rate
– The inflation rate is calculated as follows:
CPI in Year 2 - CPI in Year 1
Inflation Rate in Year 2 =
 100
CPI in Year 1
Calculating the Consumer Price Index
and the Inflation Rate: An Example
Calculating the Consumer Price Index
and the Inflation Rate: An Example
Another Example of CPI and
Inflation Calculations
 Calculating the Consumer Price Index and the
Inflation Rate:
–
–
–
–
–
Base Year is 2002.
Basket of goods in 2002 costs $1,200.
The same basket in 2003 costs $1,236.
CPI = ($1,236/$1,200)  100 = 103.
Prices increased 3 percent between 2002 and
2003.
FYI: What Is in the CPI’s Basket?
17%
Transportation
15%
Food and
beverages
Education and
communication
42%
Housing
6%
6%
6% 4% 4%
Medical care
Recreation
Apparel
Other goods
and services
The GDP Deflator vs. CPI
The BLS calculates other prices indexes:
– The index for different regions within the
country.
– The producer price index, which measures the
cost of a basket of goods and services bought by
firms rather than consumers.
CPI and GDP Deflator
Percent
per Year
15
CPI
10
5
0
GDP deflator
1965
1970
1975
1980
1985
1990
1995
2000
Japan - GDP Growth and Deflator
(sm oothed)
(%)
10
8
6
4
2
0
-2
-4
1982
1986
Real GDP Growth
1990
1994
1998
Nominal GDP Growth
2002
2006
GDP Deflator
Germany - GDP Growth and Deflator
(sm oothed)
(%)
10
8
6
4
2
0
-2
1992
1994
1996
Real GDP Growth
1998
2000
2002
Nominal GDP Growth
2004
2006
GDP Deflator
Problems in Measuring CPI
Substitution bias
Introduction of new goods
Unmeasured quality changes
Use of Price Indexes
 Price indexes are used to correct for the effects of inflation
when comparing dollar figures from different times.
 Do the following to convert (inflate) Babe Ruth’s wages in
1931 to dollars in 2005:
Do the following to convert (inflate) Babe
Ruth’s wages in 1931 to dollars in 2005:
Salary2005  Salary1931
 $80,000
Price level in 2005
Price level in 1931
195
15.2
 $ 1,026,316
The Most Popular Movies of All
Times, Inflation Adjusted
Real and Nominal Interest Rates
The nominal interest rate is the interest rate
usually reported and not corrected for
inflation.
– This is the interest rate that a bank pays.
The real interest rate is the nominal interest
rate that is corrected for the effects of
inflation.
Real and Nominal Interest Rates
You borrow $1,000 for one year.
Nominal interest rate is 15%.
During the year inflation is 10%.
Real interest rate = Nominal interest rate – Inflation
= 15% - 10% = 5%
Real and Nominal Interest Rates
Interest Rates
(percent
per year)
15%
Nominal interest rate
10
5
0
Real interest rate
-5
1965
1970
1975
1980
1985
1990
1995
2000
2005
Chapter 26
Saving, Investment
and the Financial System
Investment Rebound Led by the Technology
(% Ch. of 4-Qtr. Mov. Avg.)
($/Barrel)
80
30
20
60
10
40
0
20
-10
-20
1989
1991
1993 1995
1997 1999
2001
Total Producer Durable Equipment
Oil Price (Right)
2003 2005
2007
2009
0
Info Processing Equip.
Tax Cuts have Eased the Oil Price
Shock This Time
Average Effective Income Tax Rates
Federal, State and Local Combined
28%
Bush Tax cuts have absorbed
energy price shocks
Past Oil Price Shock came when
tax rates were rising rapidly
26%
24%
22%
Source: Prof. Larry J. Kimbell, Nov. 2004
2004
2003
2002
2001
2000
1999
1998
1981
1980
1979
1978
1977
1976
1975
1974
1973
20%
Savings And National Income Math
 GDP (as the sum of expenditures) has been defined as:
Y = C + I + G + NX
In a closed economy:
Y=C+I+G
 Rearranging terms gives:
Y-C-G=I
 The left-hand side, which is the nation's income (GDP)
leftover after consumption and government spending, is
defined as National Savings. Since Y - C - G is defined as
being equal to "S":
S=I
Continued..
 This relationship must hold for the economy as a
whole (when the economy is closed). Now, with
S=Y-C-G
 Add and subtract the government's tax revenue (T)
to the right-hand side
S=Y-C-G+T-T
 Then rearrange terms on the right hand side to get
S = (Y - T - C) + (T - G)
Continued..
 This expression breaks down national savings into
two components: private savings and public
savings.
 Private savings (Y - T - C) is the income left in the
economy after taxes and consumption have each
been paid for.
 Public savings (T - G) is equal to the taxes
collected by the government, minus government
spending. This is also an expression for the
government surplus/deficit (surplus if T > G, deficit
if T < G).
Market For Loanable Funds
Interest
Rate
Supply
5%
Demand
0
$1,200
Loanable Funds
(in billions of dollars)
Increase in Supply of Loanable Funds
Policy 1: Saving Incentives
Interest
Rate
Supply, S1
S2
1. Tax incentives for
saving increase the
supply of loanable
funds . . .
5%
4%
2. . . . which
reduces the
equilibrium
interest rate . . .
Demand
0
$1,200
$1,600
3. . . . and raises the equilibrium
quantity of loanable funds.
Loanable Funds
(in billions of dollars)
Increase in Demand of Loanable Funds
Policy 2: Investment Incentives
Interest
Rate
Supply
1. An investment
tax credit
increases the
demand for
loanable funds . . .
6%
5%
2. . . . which
raises the
equilibrium
interest rate . . .
0
D2
Demand, D1
$1,200
$1,400
3. . . . and raises the equilibrium
quantity of loanable funds.
Loanable Funds
(in billions of dollars)
Effect Of A Government Budget Deficit
Policy 3: Budget Deficit
Interest
Rate
S2
Supply, S1
1. A budget deficit
decreases the
supply of loanable
funds . . .
6%
5%
2. . . . which
raises the
equilibrium
interest rate . . .
Demand
0
$800
$1,200
3. . . . and reduces the equilibrium
quantity of loanable funds.
Loanable Funds
(in billions of dollars)
The U.S. Government Debt
Percent
of GDP
120
World War II
100
80
60
Revolutionary
War
Civil
War
World War I
40
20
0
1790
1810
1830
1850
1870
1890
1910
1930
1950
1970
1990
2010
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