A Macroeconomic Perspective on the A Macroeconomic Perspective on the Real Sector: Growth, Economic Real Sector: Growth, Economic ,,
Fluctuations and Inflation Fluctuations and Inflation Introductory Workshop toIntroductory Workshop to
Financial Programming and PoliciesYangon, Myanmar
January 19–23, 2015y ,
Jan GottschalkTAOLAMTAOLAMTAOLAMTAOLAM
IMF-TAOLAM training activities are supported by funding of the Government of Japan
OutlineOutline
I. Real Sector Overview
II. Measuring and Analyzing GDP
III. Sources of Growth
IV. Inflation
V. Forecasting GDP
2This training material is the property of the International Monetary Fund (IMF) and is intended for the use in IMF courses. Any reuse requires the permission of the IMF.
Real Sector OverviewReal Sector Overview
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Real Sector OverviewReal Sector Overview
What is the real sector about?At one level, it is about
• Level of production in the economythe economy
This means it is also about
• Employment
• Investment
• Income
• Consumption
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Real Sector OverviewReal Sector Overview
What is the real sector about?At another level, it is about prices such as
• Consumer prices• Consumer prices
• Input prices
• WagesWages
In a market economy, prices clear markets which in turn determineswhich in turn determines production levels. We cannot separate between the two
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the two.
Real Sector OverviewReal Sector Overview
How do we measure economic output?• Should we just add up all the (gross) output produced by businesses and households in the economy?
• No, this would lead to double counting! Example: wheat used in production of bread
T id d bl ti d t bt t• To avoid double counting, we need to subtract intermediate inputs: gross output - intermediate consumption = value added
• Gross domestic product (GDP): sum of value added across all sectors in the economy
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Real Sector OverviewReal Sector Overview
Why is GDP so important?
• Measure of output• Approximation of welfare• Approximation of welfare• Many other variables are moving broadly
proportional to GDP (e g revenues)proportional to GDP (e.g., revenues) GDP ratios GDP forecast is basis for revenue forecasts etc.
• Macroeconomic management: keeping GDP roughly in line with its potential
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Real Sector OverviewReal Sector Overview
Key concepts: ConsumptionWe distinguish between
• Final household consumption e g foodconsumption—e.g., food, housing, transportation• Final government consumption e gconsumption—e.g., electricity, fuel, office supplies
• Intermediate consumption—aforementioned inputs i t d ti
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into production
Real Sector OverviewReal Sector Overview
Key concepts: Investment
Additions to the i l kcapital stock, e.g.,
purchase of machinery ormachinery or construction of buildingsg
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Real Sector OverviewReal Sector Overview
Key concepts: Exports
3030Food Gas
Main Exports(In percent of GDP)
What Myanmar 20
25
20
25
Food Gas
Garments Wood
Other Total Exportsy
sells abroad…
10
15
10
15
5
10
5
10
10
002008 2009 2010 2011 2012
Real Sector OverviewReal Sector Overview
Key concepts: Imports
What you buy from abroad …
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Real Sector OverviewReal Sector Overview
Key concepts: Nominal versus Real
Nominal GDP: measures the value of output of the economy at current pricesy p
Real GDP: measures the value of output of the economy changes in an economy’s physicaleconomy -- changes in an economy s physical output -- using prices of a fixed base year
Changes in nominal GDP over time reflect changes in both prices and physical output
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Real Sector OverviewReal Sector Overview
Key concepts: Distinction between nominal versus real is useful for (1) measuring purchasing power:real is useful for (1) measuring purchasing power:
Example: Nominal wages 20%
If inflation was 10%,Real buying power grewReal buying power grew
BUTBUT
If inflation was 30%,
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Real buying power shrank
Real Sector OverviewReal Sector Overview
Key concepts: Distinction between nominal versus real f l f ( ) f d ff fis useful for (2) accounting for different GDP factors:
Value (V) = Price (P) * Quantity (Q)
Nominal GDP (V) = GDP Deflator (P) * Real GDP (Q)
Fundamental relation to be used over & over !
Approximation: ∆%V ≈ ∆%P + ∆%Qpp
Exact relationship:
(1+ ∆%V/100) =(1+∆%P/100)*(1+∆%Q/100)
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(1+ ∆%V/100) =(1+∆%P/100)*(1+∆%Q/100)
OutlineOutline
I. Real Sector Overview
II. Measuring and Analyzing GDP
III. Sources of Growth
IV. Inflation
V. Forecasting GDP
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Measuring and Analyzing GDPMeasuring and Analyzing GDP
Goods and services (real flo
Estimate of GDP
Production Approach Money (financial flow) ( sectoral "value added")
"Goods Market" Expenditure Approach ( Y = C + I + X - M )
HOUSEHOLDS PRODUCERS
"Factors Market"
NON-RESIDENTS
Income Approach (Y = wages + OS+TSP)
Wages (financial flow)
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OS=gross operating surpluses of enterprises (including profits, rents, interests)
Labor (real flow) TSP=taxes less subsidies
Measuring and Analyzing GDPMeasuring and Analyzing GDP
Production approach: GDP Shares
45%
Composition of GDP (Constant 2010/11 Prices)
35%
40% Agriculture
25%
30%Industry (incl. mining & construction)
Services and trade
20%
%
2008
2009
2010
2011
2012
2013
Services and trade
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8/09
9/10
0/11
1/12
2/13
3/14
Measuring and Analyzing GDPMeasuring and Analyzing GDP
Production approach: real GDP growth by sector
12%
14%
GDP Growth (Constant 2010/11 Prices)
8%
10%
12%
GDP (constant 2010/11 prices)
Agriculture
4%
6%Agriculture
Industry (incl. mining & construction)
S i d d
0%
2%
200
201
201
201
201
Services and trade
18
09/10
10/11
11/12
12/13
13/14
Measuring and Analyzing GDPMeasuring and Analyzing GDP
Production approach: growth contributions by sector
8%
9%
GDP Growth (Constant 2010/11 Prices)
5%
6%
7%
Services and trade
Industry (incl. mining &
2%
3%
4%dus y ( c g &
construction)
Agriculture
GDP (constant 2010/11
0%
1%
2009
2010
2011
2012
2013
GDP (constant 2010/11 prices)
19
9/10
0/11
1/12
2/13
3/14
Measuring and Analyzing GDPMeasuring and Analyzing GDP
Expenditure approach:
Absorption (A) = Final Consumption (C) + Investment (I) p ( ) ( )
Net Exports (X-M)p ( )X = Exports of goods and servicesM = Imports of goods and services
GDP = A + X – MD ti D d F i D d
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Domestic Demand Foreign Demand
Measuring and Analyzing GDPMeasuring and Analyzing GDP
Fiscal Policies
Real Sector
G; TPoliciesSector
Monetary financing/ h
Monetary financingInterest rates/exchange
rateCA=S-I
MonetaryPolicies
Balance of Payments RM=NFA+NDC
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OutlineOutline
I. Real Sector Overview
II. Measuring and Analyzing GDP
III. Sources of Growth
IV. Inflation
V. Forecasting GDP
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Sources of GrowthSources of Growth
A simple metaphor for thinking about growth:Economy as a machine: Transforming inputs such as labor
and capital into outputs such asand capital into outputs such as goods and services.
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Sources of GrowthSources of Growth
‘Economy as machine’ metaphor suggests …
… for more growth we need more inputs!
hBut many inputs such as land, labor or education are difficult
growth in the short run
to procure in the short run, so …
… growth in the short run depends really on investment.
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Is this really true?
Sources of GrowthSources of Growth
Alternatively, we need to use our existing inputs more efficiently!efficiently!This is about …
• Technical innovation (especially in advanced countries), and …• … adoption of best practices and existing technologies (especially
din emerging and developing countries)
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Sources of GrowthSources of Growth
Growth accounting—quantifying growth factorsGrowth accounting is based on production function that typically includes the following growth factors:
G h f i l hi h i l l li k d i ’• Growth rate of capital, which is closely linked to a nation’s investment rate
• Growth rate of ‘Raw’ labor, i.e., growth in labor forceGrowth rate of Raw labor, i.e., growth in labor force measured in the number of available workers
• Growth of human capital, i.e., growth in the quality of i di id l k f li k d h liindividual workers, often linked to schooling
• Technical progress, i.e., increase in efficiency of using above input factors, often called growth rate of total factor
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input factors, often called growth rate of total factor productivity (TFP)
Sources of GrowthSources of Growth
Growth accounting—advanced economiesSo what are typically the most important growth drivers?
For advanced economies, TFP growth is often key:
27Source: See DeLong, Growth Accounting, http://j-bradford-delong.net/macro_online/growth_accounting.pdf, p. 6
Sources of GrowthSources of Growth
Growth accounting—transition economies
• Capital deepening was on average thewas on average the single most important growth driver
• Closely followed by TFP growth
28Source: See Iradian (2007), Rapid Growth in Transition Countries: Growth-Accounting Approach, p. 16
Sources of GrowthSources of Growth
Growth Experience in Asial d ll l• Capital deepening was especially important in Asia, resulting
from very high investment (and savings) ratios• Human capital accumulation was another key factor in EastHuman capital accumulation was another key factor in East Asia during 1966-90
29Source: See Young (1994), Tyranny of Numbers, p. 3
Sources of GrowthSources of Growth
Recent IMF ResearchRecent IMF Research Results on Growth FactorsFactors
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Sources of GrowthSources of Growth
Investment is associated with higher growth …2 R l I ( f GDP)
20
25 Real Investment (percent of GDP)
10
15
5
10
0t [–4,0] t [1,5]* t [6,10]**
LICs ith strong gro th
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LICs with strong growthLICs with weak growth
Sources of GrowthSources of Growth
… and FDI appears especially beneficialN t F i Di t I t t Fl
4
Net Foreign Direct Investment Flows(percent of GDP)
2
3
0
1
0t [–4,0]*** t [1,5]* t [6,10]**
LICs with strong growth
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LICs with weak growth
Sources of GrowthSources of Growth
Growth takeoffs are associated with openness:R l E ( f GDP)
3035
Real Exports (percent of GDP)
152025
05
10
0t [–4,0] t [1,5] t [6,10]**
LICs with strong growth
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LICs with weak growth
Sources of GrowthSources of Growth
Reigning in high inflation promotes growth:2 I fl i (1990 2011)
20
25 Inflation (1990-2011)
10
15
0
5
[ 4 0]*** [1 5] [6 10]**t [–4,0]*** t [1,5] t [6,10]**
LICs with strong growthLICs with weak growth
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g
Sources of GrowthSources of Growth
Quality of institutions and governance is another important growth factoranother important growth factor
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Sources of GrowthSources of Growth
36Source: See Kaufmann and Kray, Growth Without Governance, p. 40
Sources of GrowthSources of Growth
37Source: See Kaufmann and Kray, Growth Without Governance, p. 40
Sources of GrowthSources of Growth
38Source: See Kaufmann and Kray, Growth Without Governance, p. 41
Sources of GrowthSources of Growth
39Source: See Kaufmann and Kray, Growth Without Governance, p. 41
Sources of GrowthSources of Growth
What does this imply for Myanmar?Myanmar’s growth performance in coming years should benefit from• Ongoing transition to market economy• Ongoing transition to market economy efficiency gains• Greater trade integrationg efficiency gains, innovation• Public sector reforms quality of institutions quality of institutions• Boost to education and health spending human capital formation
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p
OutlineOutline
I. Real Sector Overview
II. Measuring and Analyzing GDP
III. Sources of Growth
IV. Inflation
V. Forecasting GDP
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InflationInflation
What is inflation?• Inflation is a sustained increase
in the overall price level
– Increase in average prices of all goods and services vs. change in relative prices of individual goods and services
S i d i– Sustained increase vs. one-time increase in the price level
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InflationInflation
Why do we care about inflation?• Reasonably low inflation is equivalent to price stability key element of macroeconomic stabilitymatters for growthmatters for growth
• High inflation has adverse impact especially on poor• Many macroeconomic variables have a price component,Many macroeconomic variables have a price component,
for example:
l l * flNominal GDP = Real GDP * GDP Deflator
Inflation helps understanding the price component
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Inflation helps understanding the price component
InflationInflation
Inflation determinants
Π (Price Inflation)
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InflationInflationInflation determinants in Myanmar:reserve money matters …y
40%
45%
35%
40%
Reserve Money & Headline CPI (Y-o-Y Change in %)
25%
30%
35%
20%
25%
30%
10%
15%
20%
25%
5%
10%
15%
20% CPI (headline, 2010=100)
Reserve money (right axis)
0%
5%
10%
-5%
0%
5%
Ja Ju Ja Ju Ja Ju Ja Ju Ja Ju Ja Ju Ja Ju
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n-08
l-08
n-09
l-09
n-10
l-10
n-11
l-11
n-12
l-12
n-13
l-13
n-14
l-14
InflationInflation
… and so do international commodity prices:
60%
80%
35%
40%
Commodity Prices & Headline CPI (Y-o-Y Change in %)
CPI (headline
20%
40%
20%
25%
30%CPI (headline, 2010=100)
-20%
0%
5%
10%
15%All Commodity Price Index, 2005 = 100, includes
-60%
-40%
-5%
0%
Jan-0
Aug-
Mar
Oct -
May
Dec-
Jul-1
Feb-
Sep-
Apr-
Nov-
Jun-
both Fuel and Non-Fuel Price Indices
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08 -08
-09
-09
y-10
-10
11 -12
-12
-13
-13
14
InflationInflationThe role of the exchange rate becomes visible when we consider quarterly inflation rates:
15%
20%
4%
5%
Exchange Rate & Headline CPI (Q-o-Q Change in %)
0%
5%
10%
1%
2%
3%
CPI (headline, 2010=100)
15%
-10%
-5%
0%
-2%
-1%
0%
Exchange rate (lead 2, right axis)
-25%
-20%
-15%
-5%
-4%
-3%
Ja Ju No
Ap Se Fe Ju D e M Oc
M A u Ja Ju
axis)
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n-09
n-09
ov-09
pr-10
ep-10
eb-11
l-11
ec-11
ay-12
ct-12
ar-13
ug-13
n-14
n-14
OutlineOutline
I. Real Sector Overview
II. Measuring and Analyzing GDP
III. Sources of Growth
IV. Inflation
V. Forecasting GDP
48
Forecasting GDPForecasting GDP
Why does forecasting GDP matter?
• GDP forecast is the starting point for many other forecasts, e.g., revenues or imports• Similarly, GDP forecasts are necessary for projecting GDP ratiosfor projecting GDP ratios• GDP forecasts are central for macroeconomic management
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Forecasting GDPForecasting GDP
It’s difficult …• It’s very rare that the forecast hits exactly the mark (if so it’s just luck!)mark (if so, it s just luck!)• The forecast ‘number’ is important (e.g., for the budget), but …• … the ‘story’ behind the forecast is often asforecast is often as important
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Forecasting GDPForecasting GDP
General procedure• Start with analyzing the past what were key developments and how are they going to affectand how are they going to affect the present and future?• What do we know about the present (nowcast)?• Forecast is an extrapolation of past and present taking policypast and present, taking policy (changes) into account
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Forecasting GDPForecasting GDP
Remember distinction between nominal and real:
Nominal GDP: measures the value of output of the economy at current pricesy p
Real GDP: measures the value of output of the economy changes in an economy’s physicaleconomy -- changes in an economy s physical output -- using prices of a fixed base year
GDP deflator: price component of GDP, computed as Nominal GDP/Real GDP
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Forecasting GDPForecasting GDP
Typical forecasting approach:
Start with forecasting real GDP Forecast inflation Forecast inflation Forecast GDP deflator as function of inflation
f tforecast Compute
Nominal GDP = Real GDP x GDP Deflator
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Forecasting Real GDPForecasting Real GDP
Various approaches for forecasting real GDP:
Forecast– Potential output and output gapPotential output and output gap– Supply-side approach:
• Production function • Sectoral forecasts
– Demand-side approach: ppforecast expenditures (C + I + X - M)
– Reconciliation of Supply & Demand
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Forecasting Real GDPForecasting Real GDP——Potential GDP & Output GapPotential GDP & Output Gapp pp p
Positive output gap:demand > supply
Negative output gap:demand < supply
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Forecasting Real GDPForecasting Real GDP——Production Function ApproachProduction Function Approach
Q = f (K, L, A)
pppp
Q ( , , )where K = Capital
L LaborL = LaborA = Technology, Institutions
In the long run, increasing supply requires increasing A (through structural policies)increasing A (through structural policies)
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Forecasting Real GDPForecasting Real GDP——Sectoral ForecastsSectoral Forecasts
Supply-side: sectoral forecasts
Forecast production in each sector separately as they may have different determinants, then add up the individual forecasts to , pobtain the total:
Let’s practiceLet s practice this!
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Forecasting Real GDPForecasting Real GDP——Demand ApproachDemand Approach
Demand-side: forecasting expendituresGDP = (C + C ) + (I + I ) + (X – M)GDP = (CP + CG) + (IP + IG) + (X M)
Fiscal sector BOPWe should be able to forecast public consumption and investment (CG & IG) using information from the budgetWe might be able to construct forecast equations for exports and imports (X – M) [External sector]Private consumption (CP) is often fairly steady and not that difficult to forecast
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Leaves private investment (IP) as a very difficult element to forecast because this tends to be fairly volatile
Forecasting GDP DeflatorForecasting GDP Deflator
Real
Consumption Consumption
Deflator = Nominal
Consumption
Real
Investment =Nominal
Investment Deflator = Investment
Real Exports
Export Deflator =
Nominal Exports
Real Imports
Import Deflator =
Nominal Imports
Real GDP Nominal GDP
Nominal GDPGDP Deflator 100
Real GDP
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Forecasting Components of GDP DeflatorForecasting Components of GDP Deflator
Consumption: %∆ PC = %∆ CPIp C Investment: %∆ PI = (1-a) %∆ CPI + a %∆ PM
(a = share of imported investment goods)
Export:%∆ PX = ((1+%∆ Export price in US$/100) *(1 %∆ E h /100) 1) *100(1+%∆ Exchange rate/100) –1) *100
Import:%∆ P ((1+%∆ I t i i US$/100) *%∆ PM = ((1+%∆ Import price in US$/100) *(1+%∆ Exchange rate/100) –1) *100
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Forecasting Nominal GDPForecasting Nominal GDP
Putting it all together: • Forecast real GDP growth• Forecast GDP deflator
• Compute nominal GDP growth, using
Valuet+1 = Valuet (1+%P) (1+%Q)
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Forecasting GDPForecasting GDP——Other SourcesOther Sources
Forecasting tools
CCompare your own forecasts to those of the IMF!the IMF!
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OutlookOutlook
Next, we will explore in more detail …• … the fiscal sector, which helps with analyzing public consumption and investment (CG & IG)
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