Lecture 4: Basics Of Macroeconomics I (Continued)

Given to theGiven to theEMBA 8400 ClassEMBA 8400 ClassBuckhead CenterBuckhead Center

April 3, 2010April 3, 2010

Dr. Rajeev DhawanDr. Rajeev DhawanDirectorDirector

Recessions

A recession is a significant decline in activity lasting more than a few months and is visible in industrial production, employment, real income and wholesale-retail sales (NBER definition). NBER uses monthly data.

Rule of thumb is 2 consecutive quarters of negative Real GDP growth or GDP decline.

2009200520011997199319891985198119771973196919651961

14000

12000

10000

8000

6000

4000

2000

(Bil. $2005)Real GDP and Business Cycles

20092007200520032001199919971995199319911989

14000

13000

12000

11000

10000

9000

8000

7000

(Bil. $2005)Real GDP and Business Cycles

BUSINESS CYCLE REFERENCE DATES

DURATION IN MONTHS

Peak Trough Contraction Expansion Cycle

Quarterly datesare in parentheses

Peak to

Trough

Previous trough to

this peak

Trough from

Previous Trough

Peak from Previous

Peak

May 1937(II)February 1945(I)November 1948(IV)July 1953(II)August 1957(III)

April 1960(II)December 1969(IV)November 1973(IV)January 1980(I)July 1981(III)

July 1990(III)

June 1938 (II)October 1945 (IV)October 1949 (IV)May 1954 (II)April 1958 (II)

February 1961 (I)November 1970 (IV)March 1975 (I)July 1980 (III)November 1982 (IV)

March 1991(I)

13811108

101116616

8

5080374539

24106365812

92

6388485547

34117526428

100

9393455649

32116477418

108

March 2001 (I) November 2001 (IV) 8 120 128 128

December 2007 (IV) 73 81

NBER Report Cycle Dates 2003

Article: Business CyclesArticle: Business Cycles

2010200920082007200620052004200320022001200019991998

115

110

105

100

95

90

138

136

134

132

130

128

126

124

122

(Index 2002 = 100) (Mil.)Industrial Production and Employment

Ind. Production (Left) Total Payroll Employment (Right)

20102009200820072006200520042003200220012000

6

4

2

0

-2

-4

(% from a year ago)Real Disposable Income Growth

20102009200820072006200520042003200220012000

10

5

0

-5

-10

-15

(% from a year ago)Real Retail Sales Growth

FEBOCTJUNFEBOCTJUNFEBOCTJUNFEBOCT20102009200820072006

200

0

-200

-400

-600

-800

-1000

11

10

9

8

7

6

5

4

(Thous., 3-m mov. avg.) (%)Nonfarm Payrolls and Unemployment Rate

Job Growth (Left) Unemployment Rate (Right)

Article:Article: NBER’s FAQsQ: The financial press often states the definition of a recession as

two consecutive quarters of decline in real GDP. How does that relate to the NBER's recession dating procedure?– Most of the recessions identified by our procedures consist of two

or more quarters of declining real GDP, but not all of them– We consider the depth as well as the duration of the decline in

economic activity.– Second, we use a broader array of indicators than just real GDP– Third, we use monthly indicators to arrive at a monthly chronology

Q: Could you give an example illustrating this point?– The two-quarter-decline rule of thumb would not have allowed the

declaration of the recession until August 2002

Q: How does the NBER balance the differing behavior of employment and output?– There is no fixed rule for how the different indicators are weighted

The December 2007 peak was announced December 1, 2008.

The November 2001 trough was announced July 17, 2003.The March 2001 peak was announced November 26, 2001.

The March 1991 trough was announced December 22, 1992.The July 1990 peak was announced April 25, 1991.

The November 1982 trough was announced July 8, 1983.The July 1981 peak was announced January 6, 1982.

The July 1980 trough was announced July 8, 1981.The January 1980 peak was announced June 3, 1980.

Peak & Trough Announcements

Q. You emphasize the payroll survey as a source for data on economy-wide employment. What about the household survey?– Although the household survey is a large, well-designed

probability sample of the U.S. population, its estimates of total employment appear to be noisier than those from the payroll survey

Q. How do the movements of unemployment claims inform the Bureau's thinking?– A bulge in jobless claims would appear to forecast declining

employment, but we do not use forecasts and the claims numbers have a lot of noise

Q: What about the unemployment rate?– Unemployment is generally a lagging indicator. Its rise from a very

low level to date is consistent with the employment data

Article:Article: NBER’s FAQs

Source: Econmic Forecasting Center

Mar 01’ ~ Nov 01’ 9 -0.1% -4.0% 4.2 5.6Dec 07’ ~ Sept 09’ 22 -3.5% -15.0% 4.7 10.1

2009200720052003200119991997199519931991

100

98

96

94

92

90

88

86

(%)

Definition of DepressionLos Angeles Employment

Aerospace bust led to a real estate & jobs bust in early 90s

Real estate recovery was led by Hispanic buyers; Hollywood fills in the jobs vacuum somewhat

2008200620042002200019981996199419921990

105

100

95

90

85

80

(%)

Definition of DepressionDetroit Employment

2001 Recession vs. HistoryFor Details Refer:

http://www.nber.org/

FRBSF Economic Letter, June 2003

Real GDP and Consumption

FRBSF Economic Letter, June 2003

Investment and Stock Market

Facets of the “Great” Recession

20122009200620032000199719941991198819851982197919761973

30

20

10

0

-10

-20

-30

(% smoothed)

Investment Growth and Business CyclesEquipment & Software

2009200720052003200119991997

230

220

210

200

190

180

170

160

150

($ bil., 3-m. mov. avg.)Durable Goods Orders

JANOCTJULAPRJANOCTJULAPRJANOCTJULAPRJAN2010200920082007

16000

14000

12000

10000

8000

6000

Dow 30

Ongoing Recession

Dow Jones Index

GE

GE Struggles to Keep PaceGE Struggles to Keep Pace

2009200820072006200520042003200220012000

600000

500000

400000

300000

200000

100000

($)Value Change of $200,000 Home Purchased in 2000

Phoenix Los Angeles Miami Atlanta

200920082007

6

4

2

0

-2

-4

-6

-8

(%)Real GDP and Final Sales Growth

Real GDP Final Sales

Peak-to-Trough Declines in Real GDPPeak-to-Trough Declines in Real GDP

DECAUGAPRDECAUGAPRDECAUGAPRDECAUGAPRDECAUGAPR20092008200720062005

10

0

-10

-20

-30

-40

(% from a year ago)Industrial Production

Japan

US Eurozone

DECOCTAUGJUNAPRFEBDECOCTAUGJUNAPRFEBDECOCTAUGJUNAPRFEB200920082007

170

160

150

140

130

120

110

($ bil.)Total U.S. Exports

JANNOVSEPJULMAYMARJANNOVSEPJULMAYMARJANNOVSEPJULMAYMARJAN2010200920082007

5

0

-5

-10

-15

-20

-25

-30

(% change since January 2007)USD Exchange Rate Movement

USD per Euro USD per Yen

200920082007200620052004

10

5

0

-5

-10

-15

-20

(% from a year ago)Total Exports - Eurozone

DECAUGAPRDECAUGAPRDECAUGAPRDECAUGAPRDECAUGAPR20092008200720062005

-20

-30

-40

-50

-60

-70

30

20

10

0

-10

-20

-30

($ bil.) (%, Y-O-Y)International Trade

Trade Deficit (Left) Imports Growth (Right)

Weekly US Raw Steel Production Capacity Utilization (Capacity reduced as demand fell)thru January 16

30%

40%

50%

60%

70%

80%

90%

Apr-08

Jun-08

Aug-08

Oct-08

Dec-08

Jan-09

Mar-09

May-09

Jul-09

Sep-09

Nov-09

33.5% Dec 27

Source: American Iron & Steel Institute

Source: Air Transport Association

Annualized Gallons of Jet Fuel Consumed (Billions)

2009200720052003200119991997199519931991

120

110

100

90

80

70

60

(Index 2000 = 100)Transportation Services Index

Passenger

Freight

Depth of RecessionsDepth of Recessions

DateDuration (Months)

Job Losses (Mil.) Unemployment (%)

Total % Corporate Low High

Nov ‘73 – Mar ’75 17 2.115 Very Small 4.6 9.0

Jan ‘80 – Jul ’80 72.838 Less than

5%

6.3 7.8

Jul ‘81 – Nov ’82 17 7.2 10.8

Jul ‘90 – Mar ’91 9 1.621 10% 5.2 7.8

Mar ‘01 – Nov ’01 9 2.605 30% 4.2 5.6

Current (Dec ’07 – Sep ’09) 21 8.677 40% 4.5 10.1

Characteristics of Modern RecessionsCharacteristics of Modern Recessions

Source: EFC Calculations

Total Drop in EmploymentTotal Drop in Employment

(%)

What Creates Jobs?

200920072005200320011999199719951993199119891987198519831981

5.0

4.5

4.0

3.5

3.0

2.5

2.0

(%)

Investment in Tech Equipment andSoftware as a % of GDP

Golden 90’sJob Growth:240K/Month

2003-2007Job Growth:132K/Month

12%

6%

-15%

2008-2009Job Growth:-400/Month

CEO Mindset in 2010

Downturn gives Yahoo reason for revamping.

Carol BartzYahoo

Union Pacific idles cars and workers but sees some strength.

James YoungUnion Pacific

Darden runs lean, keep pricing firm at restaurant chains.

Clarence OtisDarden Restaurants

Potential taxes, new regulations worry Devon Energy.

Larry NicholsDevon Energy

Source: The Wall Street Journal, December 28, 2009

IVIIIVIIIVIIIVIIIVIIIVIIIVIIIVIIIVIIIVIIIVII20092008200720062005200420032002200120001999

70

60

50

40

30

20

10

0

-10

-20

-30

(%, Y-O-Y)

Chief Executive Confidence & Durable Goods OrdersExpectations of Business Conditions in Own Industry 6 Months Ahead

CEO Confidence (Left) Durable Goods Orders Growth (Right)

JANOCTJULAPRJANOCTJULAPRJANOCTJULAPRJANOCTJULAPRJAN20102009200820072006

120

100

80

60

40

20

16000

14000

12000

10000

8000

6000

(Index 1966 = 100)Consumer Confidence and Stock Market Wealth

Consumer Confidence (Left) Wilshire 5000 (Right)

FEBOCTJUNFEBOCTJUNFEBOCTJUNFEBOCTJUNFEBOCTJUNFEBOCTJUNFEB2010200920082007200620052004

7

6

5

4

3

2

1

(%)Yield Spread Between Treasury and Corporate Bonds

Baa - 10 Year T-Bond

200920072005200320011999199719951993

10

8

6

4

2

0

(%)Personal Savings Rate

Excl. Big Oil

(‘000 Jobs)(%, Y-O-Y)

DOW 30 Revenues and Job GainsDOW 30 Revenues and Job Gains

Excl. BOA & Chase

20122011201020092008200720062005

105

100

95

90

85

80

75

(Index 2007q4 = 100)Investment in Equipment & Software

Chapter 26

Saving, Investment

and the Financial System

Savings And National Income Math GDP (as the sum of expenditures) has been defined as:

Y = C + I + G + NX In a closed economy:

Y = C + I + G

Rearranging terms gives: Y - C - G = I

The left-hand side, which is the nation's income (GDP) leftover after consumption and government spending, is defined as National Savings. Since Y - C - G is defined as being equal to "S":

S = I

Continued..

This relationship must hold for the economy as a whole (when the economy is closed). Now, with

S = Y - C - G

Add and subtract the government's tax revenue (T) to the right-hand side

S = Y - C - G + T - T

Then rearrange terms on the right hand side to get S = (Y - T - C) + (T - G)

Continued.. This expression breaks down national savings into

two components: private savings and public savings.

Private savings (Y - T - C) is the income left in the economy after taxes and consumption have each been paid for.

Public savings (T - G) is equal to the taxes collected by the government, minus government spending. This is also an expression for the government surplus/deficit (surplus if T > G, deficit if T < G).

Market For Loanable Funds

Loanable Funds(in billions of dollars)

0

InterestRate Supply

Demand

5%

$1,200

Increase in Supply of Loanable Funds

Loanable Funds(in billions of dollars)

0

InterestRate

Supply, S1 S2

2. . . . whichreduces theequilibriuminterest rate . . .

3. . . . and raises the equilibriumquantity of loanable funds.

Demand

1. Tax incentives forsaving increase thesupply of loanablefunds . . .

5%

$1,200

4%

$1,600

Policy 1: Saving IncentivesPolicy 1: Saving Incentives

Increase in Demand of Loanable Funds

Loanable Funds(in billions of dollars)

0

InterestRate

1. An investmenttax creditincreases thedemand for loanable funds . . .

2. . . . whichraises theequilibriuminterest rate . . .

3. . . . and raises the equilibriumquantity of loanable funds.

Supply

Demand, D1

D2

5%

$1,200

6%

$1,400

Policy 2: Investment IncentivesPolicy 2: Investment Incentives

Effect Of A Government Budget Deficit

Loanable Funds(in billions of dollars)

0

InterestRate

3. . . . and reduces the equilibriumquantity of loanable funds.

S2

2. . . . whichraises theequilibriuminterest rate . . .

Supply, S1

Demand

$1,200

5%

$800

6% 1. A budget deficitdecreases thesupply of loanablefunds . . .

Policy 3: Budget DeficitPolicy 3: Budget Deficit

The U.S. Government DebtThe U.S. Government Debt

Copyright©2004 South-Western

0%

20%

40%

60%

80%

100%

120%

1790 1810 1830 1850 1870 1890 1910 1930 1950 1970 1990 2010

20112006200119961991198619811976197119661961

3

0

-3

-6

-9

-12

(%)Federal Deficit as a % of GDP

Fiscal Deficits (% of GDP) Public Debt (% of GDP)2009 2010e 2014e 2010e 2014e

Australia -4.3 -5.3 -1.1 23 28China -3.9 -3.9 -0.8 22 20France -8.3 -8.6 -5.2 85 96Germany -4.2 -4.6 0 85 89India -10.4 -10 -5.7 86 79Italy -5.6 -5.6 -5.3 120 129Japan -10.5 -10.2 -8 227 246U.K. -11.6 -13.2 -6.8 82 98U.S. -12.5 -10 -6.7 94 108G-20 -7.9 -6.9 -3.7 80 86Advanced -9.7 -8.7 -5.3 107 118Emerging -5.1 -4.1 -1.3 40 36

Fiscal Deficits and Public DebtFiscal Deficits and Public Debt

Source: PIMCO, Investment Outlook, January 2010

Source: PIMCO Investment Outlook, February 2010

A Modern Day

Fairy Tale

0908070605040302010099989796959493929190

150

100

50

0

-50

-100

($. Bil)Net Foreign Purchases of U.S. Financial Instruments

T-Bonds

Corp. Bonds

Stocks

Agency

0908070605040302010099989796959493929190

120

100

80

60

40

20

0

-20

($. Bil)China's Gross Purchases of U.S. Treasury Bonds

Source: U.S. Department of Treasury

Chapter 24

Measuring the Cost of Living

Consumer Price Index & Inflation Inflation refers to a situation in which the

economy’s overall price level is rising.

The inflation rate is the percentage change in the price level from the previous period.

The Consumer Price Index (CPI) is a measure of the overall cost of goods and services bought by a typical consumer (produced by BLS).

Inflation rate is change in CPI.

Steps to Calculate CPI Index Fix the Basket: Determine what prices are most important

to the typical consumer. – The Bureau of Labor Statistics (BLS) identifies a market basket of

goods and services the typical consumer buys.

– The BLS conducts monthly consumer surveys to set the weights for the prices of those goods and services.

Find the Prices: Find the prices of each of the goods and services in the basket for each point in time.

Compute the Basket's Cost: Use the data on prices to calculate the cost of the basket of goods and services at different times.

Choose a Base Year and Compute the Index:

Steps to Calculate CPI Index

Choose a Base Year and Compute the Choose a Base Year and Compute the Index:Index: – Designate one year as the base year, making it

the benchmark against which other years are compared.

– Compute the index by dividing the price of the basket in one year by the price in the base year and multiplying by 100.

How the Inflation Rate Is Calculated

The Inflation Rate– The inflation rate is calculated as follows:

In fla tio n R ate in Y ear 2 =C P I in Y ea r 2 - C P I in Y ea r 1

C P I in Y ea r 1 1 0 0

Calculating the CPI and the Inflation Rate: An ExampleStep 1: Survey consumers to determine a fixed basket of goods

Basket = 4 hot dogs, 2 hamburgers

Step 2: Find the price of each good in each year

Year Price of hot dogs Price of hamburgers

200820092010

$123

$234

Step 3: Compute the cost of the basket of goods in each year

200820092010

($1 per hot dog × 4 hot dogs) + ($2 per hamburger × 2 hamburgers) = $8 per basket($2 per hot dog × 4 hot dogs) + ($3 per hamburger × 2 hamburgers) = $14 per basket($3 per hot dog × 4 hot dogs) + ($4 per hamburger × 2 hamburgers) = $20 per basket

Step 4: Choose one year as a base year (2008) and compute the CPI in each year

200820092010

($8 / $8) × 100 = 100($14 / $8) × 100 = 175($20 / $8) × 100 = 250

Step 5: Use the consumer price index to compute the inflation rate from previous year

20092010

(175 – 100) / 100 × 100 = 75%(250 – 175) / 175 × 100 = 43%

Another Example of CPI and Inflation Calculations

Calculating the Consumer Price Index and the Inflation Rate:

– Base Year is 2002.

– Basket of goods in 2002 costs $1,200.

– The same basket in 2003 costs $1,236.

– CPI = ($1,236/$1,200) 100 = 103.

– Prices increased 3 percent between 2002 and 2003.

FYI: What Is in the CPI’s Basket?

17%Transportation

15%Food and beverages

Medical care

6%

Recreation

6%

Apparel

4%

Other goodsand services

3%

43%Housing

6%Education and communication

The GDP Deflator vs. CPI

The BLS calculates other prices indexes:

– The index for different regions within the country.

– The producer price index, which measures the cost of a basket of goods and services bought by firms rather than consumers.

CPI and GDP Deflator

-5

0

5

10

15

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Percent per Year

CPI GDP deflator

-5

0

5

10

15

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Percent per Year

CPI GDP deflator

20122009200620032000199719941991198819851982197919761973

15

10

5

0

-5

(% smoothed)CPI Inflation and Recessions

200920082007200620052004200320022001200019991998199719961995

4

2

0

-2

-4

-6

-8

-10

(% from a year ago)Japan - GDP Growth and Deflator

Real GDP Nominal GDP GDP Deflator

Problems in Measuring CPI

Substitution bias Introduction of new goods Unmeasured quality changes

Use of Price Indexes Price indexes are used to correct for the effects of inflation

when comparing dollar figures from different times. Do the following to convert (inflate) Babe Ruth’s wages in

1931 to dollars in 2005:

Do the following to convert (inflate) Babe Ruth’s wages in 1931 to dollars in 2005:

Salary SalaryPrice level in 2005Price level in 19312005 1931

$80,.

$

000195152

1,026,316

The Most Popular Movies of All Times, Inflation Adjusted

Real and Nominal Interest Rates

The nominal interest rate is the interest rate usually reported and not corrected for inflation. – This is the interest rate that a bank pays.

The real interest rate is the nominal interest rate that is corrected for the effects of inflation.

Real and Nominal Interest Rates

You borrow $1,000 for one year.

Nominal interest rate is 15%.

During the year inflation is 10%.Real interest rate = Nominal interest rate – Inflation

= 15% - 10% = 5%

Real and Nominal Interest Rates

-10

-5

0

5

10

15

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Inte

rest

Rat

es

(per

cen

t p

er y

ear)

Nominal interest rate Real interest rate

-10

-5

0

5

10

15

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Inte

rest

Rat

es

(per

cen

t p

er y

ear)

Nominal interest rate Real interest rate