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MGRECON301 Global Economic Environment of the Firm Professor John Coleman Duke University Fuqua School of Business October 2009 Rethinking the Boundaries of Business School Course Motivation • Why are some countries poor and others rich? • Why do countries undergo financial crises? • Why should a business manager understand his/her global economic environment? Sustained Growth and Country-Level Income Inequality is a Modern Phenomenon World-Wide Per-Capita GDP Most of the World is Poor The 21st Century may be the Century of Convergence 2007 population • 6.7 billion - World • 1.3 billion - China • 1.1 billion - India China and India represent 36 percent of the world’s population Many Poor Countries are Still Being Left Behind exchange rates national currency per dollar Financial Crises in the 90’s Mexico Thailand Russia Argentina Jan90Dec90Dec91 Dec92Dec93 Dec94Dec95 Dec96Dec97 Dec98 Dec99Dec00 Dec01 Dec02 months Time series of recent collapse U.S. Financial Crisis in 2008 Dow Jones Industrial Average The Treasury secretary, Henry M. Paulson Jr., and the Federal Reserve chairman, Ben S. Bernanke, testifying on Capitol Hill regarding the $700 billion bailout of financial firms. Year The U.S. financial crises has spread around the world: contagion. Macroeconomics and the Firm Financial Crises Corporate Profits are Very Pro-Cyclical U.S. Real GDP Note the Great Moderation beginning in the mid 1980s. Oil Price Nominal Real Outsourcing and Wages Around the World Labor costs in the manufacturing sector, $/hour (1993) 0.0 Germany Holland Japan United States France Italy Australia Britain Spain Taiw an Singapore South Korea Hong Kong Brasil Mexico Hungary Malaysia Poland Thailand China India Russia Indonesia 5.0 10.0 15.0 20.0 25.0 U.S. Current Account Monetary Policy Monetary Policy The Federal Funds Rate and the Taylor Rule Monetary Policy During the 2008/09 Financial Crises Inflation around the World World Developed Countries Developed Countries: Inflation(year-over-year) (1/01/1990 - 09/24/2008) Frequency: Quarterly Magnitude: Percent Source: Cleveland Federal Reserve Bank World: Inflation(year-over-year) (1/01/1990 - 09/24/2008) Frequency: Quarterly Magnitude: Percent Exchange Rates Yen has moved from 350 to about 100, why? The Yield Spread and Economic Growth The slope of the yield curve predicts recessions (5-year Treasury bond - 3-month Treasury bill) Annual GDP Growth or Yield Curve % Real annual GDP growth 9 7 5 3 1 -1 -3 -5 -7 Yield spread Recession Correct Recession Correct Recession Correct 2 Recessions Correct Yield curve accurate in recent forecast U.S.Treasury Yield Curve October 13, 2009 National Income and Product Accounts (NIPA) Accounting system by which we organize our thinking to measure economic activity for a country. Gross Domestic Product (GDP) • Market value of final goods and services newly produced within a nation during a fixed period of time – Market value – Newly produced final goods and services • Per capita GDP is an economy’s GDP divided by its population The Income Expenditure Identity Y=C+I+G+NX – – – – – Y=GDP (Income) C=consumption I=investment G=government purchases NX=net exports • What is produced is spent somewhere. The Income Expenditure Identity Expenditures in 1996 Billions of dollars Personal Consumption Expenditures (C) 5151 Gross private domestic investment (I) 1117 Government purchases of goods and services (G) 1406 Net exports (NX) -99 Exports 855 Imports 954 Total (equals GDP) (Y) 7576 Percent of GDP 68.0 14.7 18.6 -1.3 11.3 12.6 100.0 GDP is same as National Income GDP = National Income + Indirect taxes +Depreciation - NFP • The income approach says that what is produced is income to someone National Income Income in 1996 Compensation of employees Proprietors' income Rental income of persons Corporate profits Net interest Total (equals National Income) Billions of dollars 4449 518 127 654 403 6151 Percent of GDP 58.7 6.8 1.7 8.6 5.3 81.2 National Saving S=Y+NFP-(C+G) Current Account • This implies S=(C+I+G+NX)+NFP- C - G S=I+(NX+NFP) • CA = current account balance S=I+CA • CA=0 if closed economy (Cuba) Budget Deficit Sg = (T-TR-INT)-G • • • • • T = Tax Receipts TR = Transfers to private sector INT = interest on national debt G = Government purchases Sg=Budget surplus if positive. If negative, then a budget deficit Some Fundamental Prices The General Price Level Y = nominal GDP Y= P*y • P = GDP deflator or simply market price • y = real GDP or quantity of goods produced The General Price Level • Price growth = inflation: Pt 1 t 1 1 100 Pt • Real GDP growth: yt 1 g t 1 1 100 yt Consumer Price Inflation Interest Rates • The (short-term) interest rate is the risk-free rate of return that can be earned in the market. • R ≡ Dollar interest rate • Invest $1 today at the rate R • Receive $(1+R) in one year. How much would you pay to receive $1 in one year? Real and Nominal Interest Rates • The real interest rate, r, is the rate of return in units of goods. r=R- • (Ex post) real interest rate is nominal interest rate minus inflation. Expected Inflation and Interest Rates • The inflation rate is typically not known • Expected (ex ante) real interest rate = nominal interest rate - expected inflation re = R - e • The expected real interest rate is the nominal interest rate less expected inflation – the Fisher equation Inflation and Nominal Interest Rate in the United States R Nominal Interest Rate Inflation Bond Price and Interest Rate • How much would you pay to receive $1 in one year? • If you paid Q, then your return would be (1-Q)/Q • The return on the bond and the interest rate must be the same: Q = 1/(1+R) • Bond prices and interest rates move in opposite directions Glossary of Terms GDP NFP GNP C I G X M NX S T TR INT Pt R r Gross Domestic Product (also Y) Net Factor Payments Gross National Product = GDP + NFP National Consumption National Investment Government Expenditure Exports Imports Net exports = X - M National Saving = Spvt + Sgovt Total taxes Transfer payments Interest payments Inflation General price level at time t Nominal interest rate Real interest rate