Download Teaching the Recession1

Economic Growth [Increase in RGDP] & Instability
Inflation
“Too much money”
Business
Cycles
Unemployment
Unemployment 1960-Present
Inflation
.
Four Phases of the Business Cycle
Real GDP
per year
Peak
Peak
Trough
One cycle
[average 5 yrs]
Time
Peak: real GDP reaches its maximum.
Recession: real GDP declines 6 months.
Trough: real GDP reaches its minimum.
Recovery: an upturn - real GDP rises.
Four Phases of Business Cycle
Characteristics of Expansions and Recessions
Expansions
Recessions
1. More unemployment
1. Less unemployment
2. Decrease in Real GDP
2. Increase in real GDP
3. Reduced job growth
3. Rapid job growth
4. Lower interest rates
4. Increasing interest rate
5. Decreasing prices
5. Increasing prices
6. More social problems
6. Fewer social problems
(alcoholism, domestic violence, (alcoholism, domestic violence,
divorce and suicide)
divorce, and suicides)
Postwar Expansions/Recessions
Over 200 Years of Business Cycles
Unemployment, Inflation, & Business Cycles
Inflation – “too many dollars chasing
too few goods.”
Deflation – “too few dollars chasing
too many goods.”
Downturns in the Business Cycle
.
Recession - contraction for 2 quarters
There have been 11 recessions since World War II.
They have ranged from 6 months to 16 months, averaging
10 months. Expansions average about 5 years.
Recessions usually cost the layoff of 1 out of every 20
workers[1 out of every 4 or 5 families]. The other
19 are better off because interest rates go down.
There has been a recession every decade for over 200 years.
Trough – pit of a recession
Trough (“base”) – demand, production
and unemployment are at their lowest
point. Real GDP begins to increase again.
A trough marks the “pit of a recession”,
but – the start of an expansionary phase
of the business cycle. The Fed
lowers interest rates.
The trough is “bad news” and “good
news.” It is the bottom of the
“valley” of the downturn and the
foot of the “hill” of expansion.
The Great Depression [How Bad?]
100,000 businesses failed.
Stock values fell from $89 billion to $15 billion.
From 381 to 41.
$74 billion was lost.
25% unemployment rate [15 million](125 million
in the U.S.) [Unemployment was 3% in 1929.]
Unemployment stayed above 14.3% from
1931-1940. Average unemployment was 18%
10,797 banks failed out of over 25,000, taking
the life savings of 9 million people.
Apple sellers could make $1.15 profit on 72 sold apples.
Many factory wages went from .55 an hour to .05 an hour.
Agriculture collapsed.
Prices and wages dropped around 25%.
Factory production dropped 50%.
Auto production fell from 4.5 million cars
in 1929 to 1.1 million in 1933.
Those who checked into hotels were asked,
“For sleeping or jumping”?
Great Depression Stats [In 1958 dollars]
Year
1929
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
1940
Unempl
3.2
8.9
16.3
24.1
25.2
22.0
20.3
17.0
14.3
19.1
17.2
14.6
Real GDP “C”
“Ig”
“G”
203.6
139.6
40.4
22.0
183.5
130.4
27.4
24.3
169.5
126.1
16.8
25.4
144.2
114.8
4.7
24.2
141.5 -30% 112.8 -20% 5.3 -87%23.3
154.3
118.1
9.4
26.6
169.5
125.5
18.0
27.0
193.2
138.4
24.0
31.8
203.2
143.1
29.9
30.8
192.9
140.2
17.0
33.9
209.4
148.2
24.7
35.2
227.2
155.7
33.0
36.4
In. Rate
5.9
3.6
2.6
2.7
1.7
1.0
0.8
0.8
0.9
0.8
0.6
0.6
Inflation
___
-2.6
-10.1
-9.3
- 2.2 -23%
7.4
0.9
0.2
4.2
-1.3
-1.6
1.6
Global Depression, 1929-1932
Formulas
Base year[$50/$50=1x100=100]
$46/$50x100=92[deflation of 8%]
Price of Market Basket(2001)
[nominal GDP]
= Price of same Market Basket(1998)x100;
[GDP Deflator] in the base year (1998)
GDP Price Index
$64
[Real GDP] $50x100=128
[$64/128 x 100 = $50]
$6,737[1994]/126.1[1987($4,540)]x100 = $5,343 [+$803.]
“Real GDP deflates nominal GDP to actual value”[takes the air out of the nominal balloon]
Unemployment
Labor Force x 100 =
[Employed + unemployed]
unemployment rate;
5,655,000
140,863,000 x 100 = 4%
[135,208,000+5,655,000]
[2000]
Okun’s Law or GDP gap)=Unemployment Rate over 6% x 2%; 7.5%, so 1.5x2% = 3%.
Or, $3 billion GDP Gap[$100 billion nominal GDP x .03% = $3 billion].
(2000-later year)
(1999-earlier year)
[*Change/original x 100]
Current year’s index – last year’s index
172.2-166.6(5.6)
C.P.I. = Last year’s index(1999-earlier year) x 100; 166.6
x100 = 3.4%
_________________________
72
“Rule of 72” = % annual rate of increase (3%) = 24 years
“Real Income” measures the amount of goods/services nominal income will buy.
[% change in real income = % change in nominal income - % change in PL.]
5%
10%
5%
Indicators of the Business Cycle
[“The leading indicators have predicted
11 of the last 15 recessions”]
“Barometer
Of The Future”
[6-9 months]
“Where we are heading”
Leading Indicators
Ave. work week
Credit
New orders
New businesses
Stock prices
New orders
Building permits
Delivery times
Inventories
Materials prices
Money supply
Unemployment claims
Had a recession in 2001
A drop for three straight
months usually indicates
a recession is coming.
Indicators of the Business Cycle
“Where we are now”
Coincident Indicators
1.
2.
3.
4.
Personal income minus transfer payments
Nonagricultural payrolls
Industrial production
Manufacturing and trade sales
Indicators of the Business Cycle
“Where we have been”
Lagging Indicators
Labor cost, unemployment rate & duration, prime
rates, CPI for services, commercial loans
History of Inflation, 1860-2006
$21
$7
2006
$1.50
$11
Inflation Since 1954
Above about 2.0% inflation is
considered too much. [4.1% in 2005]
Up in 2004
Tomatoes 50%
Fuel Oil
40%
Butter
28%
Gasoline 26%
Home gas 16%
Chicken
8%
Col. Tuition 9%
Sausage
7%
Sports tickets 7%
Take some money
out of circulation
to make it more
valuable.
Down in 2004
Eggs
-20%
PCs
-14%
Photos -14%
TVs
-12%
Lettuce
-8%
Toys
-6%
Cars
-4%
Girls cloth -1%
Inflation – overall increase in prices
Deflation – decrease in prices (1954)
Disinflation – decrease in inflation(1980-83)
Demand-Pull & Cost-Push Inflation
Demand-Pull Inflation – increase in AD.
[“Too many dollars chasing too few goods”]
Originates from “buyers side of the market”
D1 D2 S
P2
P1
“Demand-pull”
D S2
PL2
PL1
S1
Cost-Push Inflation – 3 things may
cause “cost-push” inflation.
“Cost-push”
1. Wage-push – strong labor unions
2. Profit-push – companies increase prices
when their costs increase.
“Wage-price”
3. Supply-side cost shocks – unanticipated
Spiral
increase in raw materials such as oil.
Who wins/loses with 20% Unanticipated Inflation?
[Creditors, Debtors, Savers]
The debtor wins with 20% unanticipated inflation.
(some examples)
1. In 1914, total German mortgage debt was $10
billion
marks.
In 1923, $10 billion marks was worth 1 cent. All debt was wiped out.
2. Signed union contracts agreeing to 3% raises for next 3 years.
(A $30,000 salary would increase to $32,782 but it would
take $51,840 to buy what $30,000 would buy 3 years before)
3. Signed union contracts agreeing to COLAs for next 3 years.
(So a $30,000 salary of 3 years ago would now pay $51,840
which would buy what $30,000 would buy 3 years ago.
4. Your Econ teacher buys a $300,000 CD from the 1st Econ Bank
which pays him 5% interest for the next 3 years. [Saver]
Mr. Econ would earn $47,288 in interest at 5%, however at
20%, he could earn $218,400.] So the saver loses here.
(Measures of Inflation PPI)
2003
PPI was 5.4 in 2005, highest since
1990. The “core PPI” [no volatile
food and energy] was only 1.7%.
Prices at the wholesale or
production level which are early
indicators of inflation. The 2,800
items include prices for raw
materials, intermediate goods,
and finished goods. The PPI
does not include services.
Consumer Price Index (CPI)
[CPI measures cost of living relative to a base year[100]
The CPI is a market basket of 364 items at 21,000
establishments in 91 cities that the typical
householder buys. It does not include exports
because we do not buy exports but does include
imports. About 55% of the CPI is services.
The “Market Basket”
The “Market Basket”
What’s in the CPI’s Basket?
Household
10.0%
Recreation
10.4%
Clothing
6.6%
Alcohol
4.5% Health
4.3%
Shelter
27.9%
Food
18.0%
Transportation
18.3%
CPI Shortcomings
1.
2.
3.
4.
If orange goes
from $1.00 to
$2.00
Substitutes not counted
&
Quality not considered (airbags)
Tomato juice
goes from $1
No discount stores (“outlet bias”)
Plasma “42”
to .80
New items not counted
“$11,000”
st
a. 1 VCR, the Phillips 1500, the world’s
1st VCR for home use sold for $1,295
but $50 today. They fell in price 70%
before entering the CPI.
1969 Sharp QT-8D Calculator for $475 [4 functions]
[First battery-powered electronic calculator]
b. First solar powered calculators appeared in 1972 for
$120 but didn’t make the CPI until 1978.
c. In 2000, a 20-inch LCD TV cost $5,000, today $550.
d. Cell phones[The “Brick”]were introduced in 1984 at $3,995.
e. The camcorder cost $1,500 in 1987, now under $400.
f. HDTV cost $8,000 in 1998.
g. 42 inch Plasma TV in 1999 cost $11,000, now $1,500.
PPI and CPI in March 2005
GDP Deflator – more broad
GDP Deflator includes prices
for all goods that we produce:
1.What householders are buying
2.What businesses are buying
3.What the government is buying
4.What foreigners are buying
[does not include imports because
we don’t produce imports]
PCE (Personal Consumption Expenditures) Price Index
This price index is the “personal consumption” component in the quarterly GDP
report. It includes purchases of durables, non-durables, and services, including
operating expenses of nonprofit institutions, and the values of food, clothing, fuel,
housing, and financial services. Unlike the CPI [a “fixed basket”], it takes into
account changes in consumer spending (substitutions for higher priced products).
The Fed has decided this is a better indicator of inflation than the CPI, PPI, or
overall GDP Deflator.
GDP Deflator Compared to the CPI
[CPI is normally higher.]
Misery Index
Inflation Rate + Unemployment Rate = Misery Index
Arthur Okun developed the economic “discomfort
index” to summarize the “health of the economy.”
Jimmy Carter used it against Gerald Ford and won.
Ronald Reagan used it against Carter(20%) and won.
Inflation Rate
Unemployment Rate
Arthur
Okun
Misery Index
GDP
 GDP can be measured either by total
spending on U.S. production or by total
income received from that production.
Expenditure approach [C+Ig+G+Xn]
 Adds up the aggregate expenditure on all final
goods and services produced during that year
Income approach
 Adds up the aggregate income earned during the
year by those who produce that output
GDP
EXPENDITURES APPROACH
Personal Consumption Expenditure (C)
Gross Private Domestic Investment (Ig)
Government Purchases ( G )
Net Exports( Xn)
Net Exports (Xn)=Exports (X)–Imports (M)
[M represents production outside a country]
Eight Things Not Counted in GDP
[no production]
1. Second Hand Sales[no production]
2. Public/Private Transfer Payments
3. Purely Financial Transactions
4. Intermediate Goods
5. U.S. Corporations producing overseas
6. Non-market transactions
[household or volunteer work]
Underground Economy
7. Illegal business activity
8. Unreported legal business activity
Importance of Real GDP in Determining a Recession
Real GDP is Nominal GDP corrected for inflation.
Apple GDP Example
A country produces 10 apples x $1;
GDP = $10 [base year =100]
A country produces 10 apples x $1.25;
GDP = $12.50 (no recession but worse off)
Or, a country produces 9 apples x $1.25;
GDP=$11.25 (recession but nominal GDP is up)
Nominal
[money]
GDP v. Real GDP
An increase in prices and/or output will increase
nominal GDP.
Only an increase in output will increase real GDP.
Nominal GDP could increase even if output falls.
Real GDP = Nominal Y/GDP deflator x 100
So, nominal GDP measures output & prices.
Real measures only output [actual production]
Constant (real) GDP v. current (money) GDP
Nominal GDP v. Real GDP
Base year[$50/$50=1x100=100] $46/$50x100=92 [deflation of 8%]
Price of Market Basket(2001)
[nominal GDP]
$64
= Price of same Market Basket(1998)x100; [Real GDP] $50x100=128
[GDP Deflator] in the base year (1998)
[$64/128 x 100 = $50]
GDP Price Index
Nominal [Current) GDP
v.
Real (constant) GDP
The “GDP” Balloon
$6,736.9/126.1 x 100 = $5,342.5
takes
Nominal – measured in terms of money.
Real – measured in terms of goods/services.
Recession
[Real, not nominal GDP has declined]
Inflation
component
Real GDP
1990-91
UNEMPLOYMENT
Measurement of Unemployment, 2008
Under 16 and/or
institutionalized
84,200,000
Total
Population
304,000,000
Not in labor
force
76,000,000
139,600,000
Employed
Labor
force
149,800,000
Unemployed
10,200,000
Full Employment = 4-6% unemployment
Wish I had
not dropped
out of H.S..
Will work
For Food
Discouraged workers – those who have given up.
Unemployed workers - those who are actively looking.
Part-time workers – half employed, half unemployed,
but counted as fully employed.
Employed workers – those who work for even one hour
per week for wages or 15 hours a week if not getting paid.
We have full employment when cyclical unemployment is “0”.
Survey on Unemployment
BLS calls 60,000 households every month.
They ask three questions:
1. Are you working? If the answer is no,
2. Did you work at all this month-even 1 day?
You are a member of the LF if “yes” on 1 or 2.
3. Did you look for work during the last month?
[agency, resume, interview] A “yes” counts you as
part of the LF. A “no” means you are not counted.
You are a “discouraged worker.” The labor force
consists of the employed and unemployed.
Three Types of Unemployment
Frictional – “temporary”, “transitional”, “short-term.”
(“between jobs” or “search” unemployment)
Examples:
1. People who get “fired” or “quit”
to look for a better one.
2. “Graduates” from high school or
college who are looking for a job.
3. “Seasonal” or weather-dependent jobs such as
“agricultural”, “construction”, “retail”, or “tourism”.
[lifeguards, resort workers, Santas, & migrant workers.]
Frictional unemployment signals that “new jobs” are available
and reflects “freedom of choice”.
These are qualified workers “transferable” skills.
2.
Structural Unemployment
Structural – “technological” or “long term”.
There are basic changes in the “structure” of the labor
force which make certain “skills obsolete”.
Automation may result in job losses.
Consumer taste may make a good “obsolete”.
The auto reduced the need for carriage makers.
Farm machinery reduced the need for farm laborers.
“Creative destruction” means as jobs are created,
other jobs are lost. Jobs of the future destroy jobs of
today. Frictional and Structural make up the “natural
rate of unemployment”.
“These jobs do not come back.”
“Non-transferable skills” – choice is
prolonged unemployment or retraining.
3. Cyclical Unemployment
Cyclical – “economic downturns”
in the business cycle.
“Cyclical fluctuations” caused by “deficient AD”
“Durable goods jobs” are impacted the most.
These can be postponed because they can be repaired.
“Cyclical unemployment” is “real unemployment”.
“These jobs do come back.”