Download FIN 30220: Macroeconomic Analysis

FIN 30220: Macroeconomic
Analysis
Introduction to The US Economy
How do we measure a country’s size? Total production would be a
good start…but
Where do
BMWs come
from?
Germany
China
USA
Canada
Egypt
South Africa
India
Japan
Mexico
Where does your IPhone come from?
Imports of the iPhone in 2009 contributed
$1.9 billion to the U.S. trade deficit with
China.
Two measures of a country’s production
Gross Domestic Product
represents the total current
market value of all goods
and services produced
within a country over the
course of some time period
Gross National Product
represents the total current
market value of all goods
and services produced by a
country’s citizens over the
course of some time period
The Bureau of Economic Analysis (BEA) reports Gross Domestic
Product (GDP) for the United States on a quarterly basis:
For the third quarter of 2014, GDP in the
United States was (on an annualized basis)
was...
$17,599,800,000,000.00
Gross National product
$17,829,600,000,000.00
* Source: www.bea.gov
Why East Timor’s GNP is almost six times
as high as its GDP
Gross Domestic Product: $1.3B
Gross National Product: $7.54B (+580%)
Why is Ireland’s GNP so much lower than its
GDP?
Gross Domestic Product: $210.3B
Gross National Product: $164.2B (-25%)
(Do a google search on this)
How does the US Economy compare in size to other countries around the world?
(World Economy = $87T ; the countries listed below are 75% of the total)
European Union
$15.8T
Russia
$2.5T
United States
$16.7T
China
$13.4T
England
$2.4T
Japan
$4.7T
California
$2.0T
India
$4.9T
Mexico
$1.8T
Brazil
$2.4T
Australia
$998B
PPP Method 2013 est.
* Source: CIA Factbook
Gross Domestic Product represents the total current market value of all goods
and services produced within a country over the course of some time period
The average price of a Big
Mac in the United States is*
$4.62
The average price of a Big
Mac in China is*
16.60 Yuan
Problem: How do we compare economies using different currencies?
The Market Exchange rate
method involves converting
foreign prices to US dollars
using the current market
exchange rate.
*2014 Prices
1 Chinese Yuan = .16 U.S. dollars
or
1 US Dollar = 6.24 Chinese Yuan
Y16.60 x .16 = $2.65
Yuan Per US Dollar
Problem: With the extreme variability in exchange rates, is the market exchange
method accurate?
The Purchasing Power Parity method values foreign production at prevailing
US prices.
The average price of a Big
Mac in the United States is*
$4.62
The average price of a Big
Mac in China is*
1 Chinese Yuan = .16 U.S. dollars
Market Exchange rate method
16.60 x .16 = $2.65
16.60 Yuan
Purchasing Power Parity Method
VS.
$4.62
No Calculation Necessary!
The Purchasing Power Parity method assumes that if markets are functioning
properly, profitable trading opportunities will eventually be eliminated
The average price of a Big
Mac in the United States is*
$4.62
The average price of a Big
Mac in China is*
1 Chinese Yuan = .16 U.S. dollars
16.60 Yuan
$2.65 by current
exchange rate
In this example, you could make money by buying Big Macs in China and then resell them in The US.
There is a unique exchange rate that eliminates this profit opportunity.
16.60 x exchange rate = 4.62
exchange rate =
4.62
16.60
= .28 ($ per Yuan) (3.57 Yuan per $)
(This is known as the PPP exchange rate)
Dollars Per Yuan
The PPP exchange rate seems to eliminate the short term variation, but do
markets really eliminate profit opportunities?
PPP
.28
55%
.16
“Overvalued”
Valuing currencies using the Big
Mac Standard
“Undervalued”
China
Note that the method by which countries are evaluated sometimes greatly
change the results!
PPP Approach
Market Exchange Rate
Country
GDP
Rank GDP
Rank
USA
$16.72T
#1
$16.72T
#2
European Union
$15.84T
#2
$17.03T
#1
China
$13.39T
#3
$9.33T
#3
India
$4.96T
#4
$1.76T
#7
Japan
$4.73T
#5
$5.00T
#4
Germany
$3.23T
#6
$3.60T
#5
Russia
$2.55T
#7
$2.11T
#6
*2013 Estimate
** CIA Factbook
Lets use the PPP method as a reasonable method for comparing countries.
Per Capita GDP is calculated by dividing total GDP by the current
population.
Per Capita GDP =
$17T
320M
= $53,125
Per capita GDP is a better measure of the well being of an average
American.
* Source: www.bea.gov
In Per Capita Terms, the US drops to #14 while China drops to #121 ($9,800)!!
The European Union comes in at #41 ($34,500)
Note: 2013 GDP estimates measured on a Purchasing Power
Parity Basis
* Source: CIA Factbook
Side note: Calculating rates of growth:
100
125
t=0
t=1
140
160
t=2
t=3
175
t=4
How would you calculate this rate of growth?
100 to 125 is a 25% increase…
 125  100 

 *100  25%
 100 
But, from 125 to 100 is a 20% decrease?
 100  125 

 *100  20%
 125 
Which is it??
Using natural logs is the preferred method because the forward/backward
problem is eliminated!
100
125
t=0
t=1
140
160
t=2
t=3
100 to 125 is a 22.3% increase…
ln 125  ln 100*100  22.3%
And, from 125 to 100 is a 22.3% decrease
ln 100  ln 125*100  22.3%
175
t=4
A better measure of economic performance would be the rate of growth in
output rather than the level of output
Year on
Year
Growth
Period
GDP (Billions)
2013Q3
2013Q4
2014Q1
2014Q2
2014Q3
16,872
17,078
17,044
17,328
17,599
Year on Year growth (2013Q3-2014Q3)
ln 17,599   ln 16,872   *100  4.2%
Annualized
Growth
Annualized Growth (2014Q3)
ln 17,599   ln 17,328   * 4*100  6.2%
However, be careful here!
GDP measures current dollar value of all goods and services produced. When
GDP rises, its impossible to distinguish between an increase in production and
an increase in prices!!
Economy A: Zero growth, high inflation.
Year
2010
Price
$1
Quantity GDP
100
$100
2011
$1.25
100
$125
Economy B: Rapid growth, no inflation.
Year
2010
Price
$1
Quantity GDP
100
$100
2011
$1
125
$125
Both have
(approximately)
25% annual
growth in GDP!!!
We can approximate real growth by subtracting the inflation rate
Period
GDP (Billions)
Price Level
2013Q3
2013Q4
2014Q1
2014Q2
2014Q3
16,872
17,078
17,044
17,328
17,599
106.9
107.3
107.6
108.2
108.6
Year on Year growth (2013Q3-2014Q3)
Annualized Growth (2014Q3)
ln 17,599   ln 16,872   *100  4.2%
ln 17,599   ln 17,328   * 4*100  6.2%
Year on Year Inflation (2013Q3 - 2014Q3)
Annualized Inflation (2014Q3)
ln 108.6   ln 106.9   *100  1.6%
ln 108.6   ln 108.2   * 4*100  1.5%
Real Growth = 2.6%
Real Growth = 4.7%
* Source: www.bea.gov
In terms of real GDP Growth the US drops to #157
Note: 2013 GDP estimates measured on a Purchasing Power
Parity Basis
* Source: CIA Factbook
How would you calculate the average per period growth?
100
t=0
175
t=1
1


 
4


 175   1 *100  15%
 100 



We have the same
forward/backward
problem here
t=2
or
t=3
t=4
 ln 175  ln 100 
*100  14%


4

No forward/backward
problem here!!
Perhaps to get a better sense of the US, we should look at average
performance over a long time period.
Year
1947Q3
GDP
$250B
Price
13.3
2014Q3
$17,599B
108.6
Price Growth (Inflation)
Total Growth
 ln 17,599   ln  250  

 *100  6.3%
67


 ln 108.6   ln 13.3 

 *100  3.2%
67


Real Growth = 6.3% - 3.2% = 3.1%
Note that the US seems to be slowing down…we’ll talk about this later
Average Real
Growth = 3.2%
Current Real
Growth
Let’s compare the US with countries that are in our “peer group” in terms of
development:
United States
European Union
•GDP: $17.0T
•GDP Per Capita: $50,000
•Real GDP Growth: 2.0%
•Inflation Rate: 1.6%
•GDP: $15.8T
•GDP Per Capita: $34,500
•Real GDP Growth: 1.6%
•Inflation Rate: 1.5%
*Source: CIA Factbook (2013 estimates)
~70% of US
Let’s look at historical data for the US and Europe. Europe fell behind the
US in the mid 1800s and has been struggling to catch up ever since!
Real Per Capita GDP, Europe and the United States: 1820 - 2000
To understand this, let’s look at the sources of economic growth….where does GDP
come from?
“is a function of”
Real GDP
Y  F  A, K , L 
Productivity Capital
Employment
Therefore, we should be able to break down economic growth into its individual
components
Capital
Growth
Real GDP
Growth
%Y  F  %A,%K ,%L 
Productivity
Growth
Employment
Growth
So, what jumps out at you?
Real GDP
Growth = 2.35%
Real GDP
Growth = 1.42%
Real GDP
Growth = 2.15%
Real GDP
Growth = 2.57%
Real GDP
Growth = 1.72%
Real GDP
Growth = 2.94%
It seems that the biggest difference between the US and Europe involves
employment and productivity. With that in mind, let’s decompose GDP per capita
differently…
GDP per
hour
(productivity)
Employment
(% of Population)
Y
 Y   hr   E 

   *   * 
Pop  hr   E   Pop 
GDP per
capita
Hrs. per
employee
Lets measure output per hour in the US (a reasonable measure of productivity)…
Employed
139 Million
Recall, GDP = $17 Trillion
139 Million X 1,794 (hours/yr.) = 250 Billion hours per year
$17T
= $68 Per hour
250B Hrs.
Here’s American productivity relative to European productivity.
Country
Labor
Productivity
(2004) *
Productivity Growth
(1989 -2000)
Productivity Growth
(2000-2005)
USA
100
1.7%
2.5%
Germany
92
1.7%
1.0%
France
107
1.5%
1.3%
Italy
92
1.7%
0.0%
England
87
1.8%
2.0%
* USA = 100
** Source: OECD
As with GDP per capita, productivity in Europe has lagged behind that
of the US until recent years.
Real GDP per Hour, Europe and the United States: 1870 - 2000
Europe had been falling behind the US in both productivity and output per capita
until recent years. However, while productivity has caught up with the US, output
per capita still lags.
Ratio of Europe to the United States: 1820 - 2000
Productivity in Europe is comparable to the US, but output per capita is much
lower. How can that be?
Equal to the
US
Y
 Y   hr   E 
   *  * 
Pop  hr   E   L 
Lower in
Europe
This must be lower
in Europe!
The US has maintained a lower average unemployment rate that Europe as
well as a higher employment rate
Country
Unemployment
Rate (Average)
Average annual hours
USA
5.0%
1,794 (34.5 hrs per wk)
Germany
10.0%
1,426 (27.4 hrs per wk)
France
9.0%
1,441 (27.7 hrs per wk)
Italy
9.0%
1,585 (30.4 hrs per wk)
England
5.5%
1,669 (32.0 hrs per wk)
** Source: OECD
Lately, we have seen wages diverge from productivity …especially in the US!
Country
Labor
Productivity
(2004) *
Real Compensation
(2004)* - Using Mkt.
Exchange Rates
Productivity
Growth (20002005)
Real Compensation
Growth (2000 -2005)
USA
100
100
2.5%
1.7%
Germany
92
147
1.0%
-0.5%
France
107
103
1.3%
0.9%
Italy
92
88
0.0%
0.5%
England
87
107
2.0%
3.4%
* USA = 100
** Source: OECD
The “wage gap” is the difference between productivity and wages
Index: 1947 = 100
450
400
350
300
250
200
150
From the early
1980’s on, we
100
50
0
1947-01-01
1957-01-01
1967-01-01
1977-01-01
Real GDP Per Hour
1987-01-01
1997-01-01
Real Compensation Per Hour
2007-01-01
Historically, labor’s share of income has been constant at around 65%, but has
decreased since the 1980s.
Percent
70
68
66
65%
64
62
60
58
56
So, where is the extra income going?
?
Note that the distribution of household income is skewed to the left. That is, there
is a large segment of the population that is below average income
4,500
4,000
Median Household Income = $50,000
3,500
Mean Household Income = $68,000
3,000
2,500
2,000
1,500
1,000
500
0
Under $2,500
$12,500 to
$14,999
$25,000 to
$27,499
$37,500 to
$39,999
Source: US Census Bureau (www.census.gov)
$50,000 to
$52,499
$62,500 to
$64,999
$75,000 to
$77,499
$87,500 to
$89,999
Total Households = 121M
One indicator of growing inequality is a separation of the mean and the median
Source: US Census Bureau (www.census.gov)
Average Income by Quintiles (2012)
$119,000+
$76,000 - $119,000
$50,000 - $76,000
$27,000 - $50,000
$0 - $27,000
Source: US Census Bureau (www.census.gov)
The Lorenz Curve
The Lorenz curve plots the cumulative distribution of US income
The Gini Coefficient
A
Gini 
A B
The US currently has a Gini
coefficient of .45
0 = Perfect
Equality
1 = Perfect
inequality
The Gini coefficient allows us to “quantify” the differences in income inequality
across countries.
Country
Gini (1989)
Gini (2007)
% Change
USA
.338
.450
28%
Germany
.257
.270
5%
France
.287
.306
7%
Italy
.303
.333
9%
England
.336
.323
-4%
*Source: Luxembourg Income Study
The fact that income inequality in the US is rising is reflected in a
rising Gini coefficient
This suggests that while the
US market based economy is
a real engine of growth, not
everyone benefits equally
from our economic
success…the poor are getting
poorer relative to the wealthy!
Start of the “wage gap”
Note that income inequality in the US was worse back in the 1920’s
The Good Old Days: Economic Growth
from 1947-1973
The Times, They are a Changin’: Economic
growth from 1977-1989
Here we can see both the declining growth as well as the rising inequality.