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Macroeconomics Mini-course
Professor Pierre Yared
Questions
• What is GDP?
• What drives economic growth?
• What drives investment?
• What drives inflation and exchange rates?
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Questions
What is GDP?
3
World GDP
Share of world production, 2002, using current exchange rates
4
GDP Definition
Gross Domestic Product (GDP)
The market value of final goods and services newly produced
within a fixed period of time, within the geographic
boundaries of a country
5
Three Equivalent Ways of Measuring GDP
• Production Approach
• Inputs (capital and labor) generate output
• Value added by individual firms
• Sectoral data (e.g., agriculture, manufacturing, services)
• Income Approach
• Payments made to inputs into production
• Wages to workers and rental rate to owners of capital
• Expenditure Approach
• Components: Consumption, investment, public spending, net exports
• Most important and common way of measuring GDP
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GDP by Expenditure: International Comparisons, 2007
China
G,
13%
NX,
9%
Brazil
C,
36%
G,
20%
I,
15%
I,
43%
US
G,
19%
NX, 5%
I,
15%
NX,
2%
C,
63%
Sweden
NX,
8%
G,
26%
C,
70%
C,
47%
I,
18%
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Questions
What drives economic growth?
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US Growth Experience
$35,000
US
Real GDP per capita
$30,000
Canada
Australia
Japan
Germany
U.K
$25,000
$20,000
$15,000
Argentina
Mexico
Brazil
$10,000
$5,000
China
India
Nigeria
$0
1860
1880
1900
1920
1940
1960
1980
2000
2020
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How Do We Make Sense of Different Growth Experiences?
6000
Real GDP per Capita in 1996 Chain weighted $ (PWT)
5000
4000
China
3000
Congo, Dem. Rep.
2000
1000
0
1965
1970
1975
1980
1985
1990
1995
2000
2005
Year
10
Production Over Many Years
Capital
Production
Labor
Consumption + Public
Spending + Net Exports Investment
New
Production
Even More
Capital
New Labor
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Three Ways of Increasing GDP per Capita
• Capital per worker
• More machines per worker raises output per person
• Increases if investment is rising faster than the size of the work force
• Participation rate
• A higher fraction of population in workforce raises output per person
• Major increases have occurred through women’s liberation
• Total factor productivity (TFP)
• Corresponds to production process (black box) in flow diagram
• Implication: Same inputs can produce different outputs
• Most important determinant of cross-country income differences
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Latin America Has Not Caught Up: Why?
Y/Pop =
N/Pop 
A 
(K/N)0.3
1950
Latin America
3,100
.34
US
11,100
.40
Latin America / US
.28
.85
.49
(.27).3 = .68
.42
(.32).3 = .71
2000
Latin America
7,400
.35
US
33,400
.48
Latin America / US
.22
.73
Based on data and analysis in Cole, Ohanian, Riascos, Schmitz (2005)
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What is Behind Total Factor Productivity?
• Education
• Important for workers to have skills and abilities to be productive
• Important to accumulate these over time through schooling
• Geography
• Important to develop effective agriculture to start growth
• Important to have low disease and a healthy workforce
• Important to have access to trade to adopt technology
• Institutions
• Important to prevent expropriation of investment by government
• Important to enforce legal contracts among parties
• Important to have low policy volatility and stable business environment
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Questions
What drives investment?
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Investment is Financed by Savings
Private Savings
+
Public Savings
+
International Savings
=
Investment
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Three Sources of Savings
• Private Savings
• Households can set aside resources or borrow them
• Businesses can also borrow or lend
• Public Savings
• Governments can set aside resources or borrow them
• Government deficit is negative of public savings
• i.e., Public spending minus revenues
• Private Savings + Public Savings = National Savings
• International Savings
• Neighbors can set aside resources or borrow them
• Current account deficit is international savings
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Saving Identity in the US (% of GDP)
25%
Investment
20%
Private
Savings
15%
10%
Government
Savings
5%
International
Savings
0%
50
55
60
65
70
75
80
85
90
95
00
05
-5%
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Questions
What drives inflation and exchange rates?
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US Inflation
Inflation
y-o-y% change in CPI
16%
14%
12%
percent
10%
8%
6%
4%
2%
0%
59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07
-2%
Date
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China Inflation
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Montly Percent Change (non-annualized)
-1.0
Jan-06
Jan-03
Jan-00
Jan-97
Jan-94
July 89: 197%
Jan-91
Jan-88
Jan-85
Jan-82
Jan-79
Jan-76
Jan-73
Jan-70
Argentina Hyperinflation
Monthly Inflation in Argentina
49.0
March 90: 96%
39.0
29.0
19.0
9.0
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Determinants of Inflation
• Inflation is measured as the rate of change of the price level
• Various measures: CPI, GDP deflator, CPE
• Headline inflation: aggregates all prices
• Core inflation: Excludes food and energy and is less volatile
• What determines long run inflation? Money growth
• Also applies to hyperinflation at shorter frequencies
• Why do governments allow hyperinflation?: Seignorage
• Inflation is a form of indirect taxation on holders of money
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Determinants of Exchange Rates
• Long run: Inflation differences affect exchange rate
• Currency experiencing more inflation is also depreciating
• Implication: Can fight hyperinflation by fixing exchange rate
• Medium run: International trade competition affect exchange rates
• Tendency for real price of goods to equalize through competition
• Cheaper goods from one country cause its currency to appreciate
• If central bank fixes exchange rate, nominal price of goods will rise
• Short run: Interest rate movements affect exchange rates
• Increase in interest rate in one country causes its currency to rise
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Summary of Questions Answered
• What is GDP?
• What drives economic growth?
• What drives investment?
• What drives inflation and exchange rates?
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