fin 30220: macroeconomic analysis measuring the u.s. economy
TRANSCRIPT
FIN 30220: Macroeconomic Analysis
Measuring the U.S. Economy
U.S. GDP of $17 Trillion represents approximately one fifth of total worldwide production ($85 Trillion) and makes the United States the largest single country economy on the planet!!
02468
1012141618
* Source: CIA FactbookNote: 20013 GDP estimates measured on a Purchasing Power Parity Basis
GDP is the standard benchmark for economic well being. Is it a good indicator of well being? VS
1950: $275B
2010: $14,600B
1950: $1,696B
2010: $12,973B
1950: $10,941
2010: $42,120
1950: $20,000
2010: $50,233
Principle #1: What exactly are you trying to measure? Is your definition consistent with what you are trying to measure?
Rat
io
2005 Dollars 2008 Dollars2005 Dollars
GDP is the standard benchmark for economic well being
VS
Annual defense spending has grown from $35B in 1950 to $795B in 2009. Should this be subtracted out?
The service industry has grown from 30M employees in 1950 to 113M in 2009. Is this really “new activity”?
Should we count things like pollution as economic “bads”? How do we account for the added quality and convenience of new products and technologies?
The Genuine Progress indicator corrects for social “bads”
VS
Gross Domestic Product measures the current market value of all goods and services produced within a country’s borders over a certain time period (usually a quarter)
Farmer A produces 1,000 bushels of Apples (Apples cost $10/bushel)
Farmer B produces 2,000 bushels of Corn (Corn costs $15/bushel)
GDP = ($10)(1,000) + ($15)(2,000) = $40,000
Principle #2: How is your variable measured?
Suppose that Intel produces 1,000 computer chips (P = $100)
100 Chips sold to consumers
900 Chips sold to Dell
Dell produces 500 computers (P = $1,000)
$100,000
$500,000- $90,000
$40,000
- $0
$100,000
$450,000
Sales
Materials Expenses
Materials Expenses
Sales
Change in Inventories
Total = $550,000
Value Added Approach
(The remaining 400 chips were added to Dell’s inventories)
Example: Microsoft
Sales: $600,000
Expenses: $420,000• Labor Costs: $200,000• R&D Costs: $50,000• Materials: $100,000• Lease: $20,000• Utilities: $10,000• Equipment Purchase: $40,000
Inventories:• BOY: $620,000• EOY: $640,000
Value Added:
$600,000 - $220,000 (Non-Labor Exp)+ $40,000 (Equipment Inv)+ $20,000 (Inv. Investment)+ $50,000 (R&D) – NEW $490,000
Product Markets
Factor Markets
Factor Services
Goods & Services (GDP)
Income
Expenditures
The Circular Flow of Payments suggests that we could also calculate GDP by measuring total expenditures on the goods and services produced
GICY G GDP
Gross Business Investment
Structures
Equipment
Inventories
Residential Investment
Consumer Expenditures
Durables
Non-Durables
Services
Government Purchases (Federal, State, and Local)
Suppose that Intel produces 1,000 computer chips (P = $100)
100 Chips sold to consumers
900 Chips sold to Dell $0
$40,000 Inventory Investment
Total = $550,000
Expenditure Approach
$510,000 Consumer Durables
Dell produces 500 computers (P = $1,000)
(The remaining 400 chips were added to Dell’s inventories)
What’s so Gross about GDP?
Suppose that we have the following information from GM’s financial statements
Sales: $300M
Depreciation: $5M
Change in Inventories: $20M
Materials Costs: $150M
$300,000- $150,000
$20,000
Materials Expenses (000s)
Sales (000s)
Change in Inventories (000s)
Total = $170,000
Strictly speaking, depreciation should be counted as a cost of production. GDP calculations do not include depreciation expenses!
•Exports of Goods and Services
•US Citizens Working Abroad
•Imports of Goods and Services
•Foreign Citizens Working in the US
US Acquisition of Foreign Assets
Foreign Acquisition of US Assets
BMW operates a manufacturing facility in Spartanburg South Carolina. Meanwhile, Nike operates 73 production facilities in Thailand. How should we count this production?
$130,000- $70,000 Labor Costs (000s)
Value Added (000s) $400,000- $50,000 Labor Costs (000s)
Value Added (000s)
$60,000 Profits (000s) $350,000 Profits (000s)
Gross Domestic Product = Total Production within US borders
Gross National Product = Total Production by US Citizens
The $60,000 in profits from BMW accrue to foreign nationals and should not be counted in US GNP. However, GNP would need to include the profits from Nike’s Thailand plants.
BMW operates a manufacturing facility in Spartanburg South Carolina. Meanwhile, Nike operates 73 production facilities in Thailand. How should we count this production?
$130,000- $70,000 Labor Costs (000s)
Value Added (000s) $400,000- $50,000 Labor Costs (000s)
Value Added (000s)
$60,000 Profits (000s) $350,000 Profits (000s)
GDP = $130,000GNP = $70,000 + $350,000 = $420,000
$420,000 = $130,000 +($350,000 - $60,000)
GNP GDP Net Factor Payments
With the global economy, we need to keep track of expenditures between the US and the rest of the world as well as domestic expenditures
NXGICY G GDP
Gross Investment
Consumer Expenditures
Government Purchases
Net Exports = Exports - Imports
Category Amount (B) % of Total
Consumption $11,792 69%
Gross Investment $2,694 16%
Government $3,116 18%
Net Exports -$501 -3%
GDP $17,101 100%
GDP is calculated using a method of double entry accounting – each dollar of production should have a corresponding expenditure.
GDP: 2014Q1
Recall that total income (national income) in the US should accrue from the production undertaken by American citizens
Gross Domestic Product = $17,101BFirst, we need to correct for income earned abroad as well as domestic production accruing to foreign nationals
+ Net Factor Payments = $235B
Gross National Product = $17,336BNow, recall that depreciation is an expense that should be deducted as a production cost
- Depreciation Expense = $2,721B
Net National Product = $14,615B
Finally, we need to correct for indirect taxes/transfers (essentially, sales taxes)
- Indirect Taxes = $198B
National Income = $14,417B
National Income by Source: 2014Q1Category Amount(B) % of Total
Wages $9,040 62%
Proprietor’s Income $1,366 9%
Rental Income $611 4%
Income on Assets $2,030 14%
Transfer receipts $2,504 17%
Less Contributions - $1,134 6%
National Income $14,417 100%
NXGICGDP G
To get to the flow of funds accounts, begin with GDP equals aggregate expenditures
Now, add net factor payments to both sides
CAGICGNP G Current Account = NX + NFP
Lastly subtract depreciation and indirect taxes from both sides
CAGICNI N Net Investment (Gross Investment minus depreciation)National
IncomeConsumer Outlays (Net of Indirect Taxes)
CAGICNI N National Income = Personal Income + Undistributed Corporate Profits
CATGICTNI N Now, Subtract Consumption from both sides…
CATGISCTNI N
Subtract taxes from both sides….
The flow of funds measures financial market transactions
Net Private Saving = Personal Saving + Undistributed Profits
CATGIS N
Last year, the US current account was -$380B. What does this mean?
CAGICNI N
Total US IncomeTotal US Outlays Net lending abroad
In other words, the US is borrowing $1B per day from abroad! Should we be worried about this?
This number continues to shrink as US consumers overspend!!
This number continues to grow as the US government overspends!!!
-900
-800
-700
-600
-500
-400
-300
-200
-100
0
1001960-01-01 1970-01-01 1980-01-01 1990-01-01 2000-01-01 2010-01-01
Think of the current account as the savings of the entire economy. We have become a debtor nation!
Billions of D
ollars
What a wacky world we live in!
CCCCC CATGIS
Currently, China is running a $30B trade surplus with the world
USUSUSUSUS CATGIS
Currently, the US is running a $380B trade deficit with the world
What’s wrong with this picture?
Nominal Variables are in terms of a current year’s prices. For example, you’re starting salary after college might be $50,000 per year.
Real variables are in terms of some tangible commodity or some constant year’s prices. Real variables measure purchasing power.
Principle #3: Is your variable in terms of current prices or fixed prices (Real vs. Nominal)
VS.
How do we construct a measure of prices?
The objective of a price index is to measure cost of living. To state this precisely, a price index measures the dollar cost of obtaining a fixed level of utility (happiness).
Example:
$3.50 $2.00
Suppose at the current prices, you elect to buy 3 slices of pizza and 2 beers
The absolute dollar cost of your current happiness is (2)($3.50) + (3)($2.00) = $13
If beer increases in price to $4.50 (25% increase) and pizza increases to $2.20 (10% increase), this level of happiness now costs
(2)($4.50) + (3)($2.20) = $15.60
ln 15.60 ln 13 *100 18%
Good Base Year Price (BY)
Base Year Quantity
Current Year Price (CY)
Inflation
Beer $3.50 2 $4.50 25%
Pizza $2 3 $2.20 10%
Base Year Expenditure: (2)($3.50) + (3)($2.00) = $13
Beer Expenditure Share: (2)($3.50)/$13 =.54Pizza Expenditure Share: (3)($2)/$13 = .46
Alternatively, we could write the price index in terms of relative dollars (relative to a base year) instead of absolute dollars
4.50 2.20.54 .46 1.2
3.50 2.00CYP
3.50 2.00.54 .46 1.0
3.50 2.00BYP
(Or, 100)
(Or, 120)
ln 120 ln 100 *100 18%
The CPI is calculated by the Bureau of Labor Statistics (BLS) on a monthly basis
Education & Communication
5%
Tobacco & Smoking Products
1%
Recreation6%
Medical6%
Housing40%
Food & Beverage16%
Apparel5%
Personal Care4%
Transportation17%The CPI is composed of
211 individual products over 38 geographic areas.
Consumer Price Index
When calculating the CPI, be sure to use the same weights each year!
Good Base Year Price (1983)
Year 2013 Price Year 2014 Price
Housing $200 $780 $800
Transportation $90 $280 $300
Food $40 $190 $200
Apparel $30 $245 $250
Household Budget
2013
780 280 190 245.40 .30 .20 .10 4.25
200 90 40 30CPI
CPI inflation (2013 – 2014)
ln 4.43 ln 4.25 *100 4.15%
(Or, 425)
The CPI is an example of a fixed weight index
2014
800 300 200 250.40 .30 .20 .10 4.43
200 90 40 30CPI
( or, 443 )
1983
200 90 40 30.40 .30 .20 .10 1
200 90 40 30CPI
( or, 100 )
Average CPI inflation
ln 443 ln 100*100 4.80%
31
1983 = 100
CP
IC
PI Inflation R
ate
CPI
The Consumer Price Index (1948 – 2014)
Average Inflation = 3.54%
Note That expenditure shares do change over time, so the weights need to be updated periodically
Potential Problem:
$3.50 $2.00
Suppose at the current prices, you elect to buy 3 slices of pizza and two beers
The cost of your current happiness is (2)($3.50) + (3)($2.00) = $13
If beer increases in price to $4.50 (25% increase) and pizza increases to $2.20 (10% increase), suppose you alter your decision and buy 1 beer and 4 slices of pizza
(1)($4.50) + (4)($2.20) = $13.30
ln 13.30 ln 13 *100 2.2%
Good Base Year Price (BY)
Current Year Price (CY)
Inflation
Beer $3.50 $4.50 25%
Pizza $2 $2.20 10%
No Substitution:
Original Expenditure:
(2)($3.50) + (3)($2.00) = $13
(1)($4.50) + (4)($2.20) = $13.30
ln 13.30 ln 13 *100 2.2%
Substitution:
(2)($4.50) + (3)($2.20) = $15.60
Which measure of inflation is more realistic?
ln 15.60 ln 13 *100 18%
In 2000, the BLS introduced a “chain weighted CPI” that allows for this substitution between different goods. It’s thought to be a better gauge of inflation
CCPI
Inflation RateC
hain
ed C
PI
It is, however, very controversial…In
flatio
n R
ate
Average Inflation Rate
CPI: 2.31%CCPI: 2.06%
CPI Inflation Rate (2.31% per year)
CCPI Inflation Rate (2.06% Per Year)
Suppose that you are a social security recipient. Let’s calculate your total payments received in social security payments under the different inflation measures from 2000 to 2014. (Assume you received $1,000 per month in 2000)
2 14$12,000 $12,000 1.0231 $12,000 1.0231 ... $12, 000 1.0231 $212,232
2 14$12,000 $12,000 1.0206 $12,000 1.0206 ... $12, 000 1.0206 $208,442
Difference = $3,790 (1.8%)
Now, consider that there are approximately 65 million social security recipients:
$3,790*65M = $246B
Another potential problem: Products change over time. Suppose you observe the following TV Prices
Price: $250Features: 27 inch
Cathode Ray TubeEnhanced Definition TVS-Video InputUniversal Remote
Price: $1,250Features: 42 inch
PlasmaHigh Definition TVS-Video InputUniversal Remote
$1,250 $250*100 400%
$250
2003
Note: The first plasma TV was released by Fijitsu 1n 1995. The 42’’ TV cost $14,999
2004
Is this a fair assessment of inflation?
0 1 1 2 2ln ... N NP X X X
What do we value in a TV? (At least, what is reflected by price)
Natural log of retail price
Television Features
Solution: Hedonic price adjusting
Characteristic Category Characteristic Name Coefficient
Intercept 3.4455
Display Type Projection -.25586
CRT Base (0)
DLP .58356
LCD Projection .38566
LCD Direct View .73075
Plasma .72843
Screen Size .08348
(Screen Size)^2 -.00049
Features Picture in Picture .08430
Universal Remote .16261
High Def (HDTV) .34280
Extd Def (EDTV) .12228
3D Comb. Filter .07122
Flat Screen .18461
S-Video Input .13722
DVD Built in .38247
What do we value in a TV? (At least, what is reflected by price)
Plasma TVs sell for 73% more that CRT TVs
Each 1’’ increase in screen size raises the price by 8%
HDTV is priced 22% more than EDTV
Characteristic Category
Characteristic Name Coefficient Value
Intercept 3.4455 3.4455
Display Type Projection -.25586 0
CRT Base (0) 0
DLP .58356 0
LCD Projection .38566 0
LCD Direct View .73075 0
Plasma .72843 0
Screen Size .08348 27*.08348
(Screen Size)^2 -.00049 27*27*(-.00049)
Features Picture in Picture .08430 0
Universal Remote .16261 .16261
High Def (HDTV) .34280 0
Extd Def (EDTV) .12228 .12228
3D Comb. Filter .07122 0
Flat Screen .18461 0
S-Video Input .13722 .13722
DVD Built in .38247 0
Total 5.64208
First, value all the features on the old TV
Price: $250Features: 27 inch Cathode Ray Tube Enhanced Definition TV S-Video Input Universal Remote
Characteristic Category
Characteristic Name Coefficient Value
Intercept 3.4455 3.4455
Display Type Projection -.25586 0
CRT Base (0) 0
DLP .58356 0
LCD Projection .38566 0
LCD Direct View .73075 0
Plasma .72843 .72843
Screen Size .08348 42*.08348
(Screen Size)^2 -.00049 42*42*(-.00049)
Features Picture in Picture .08430 0
Universal Remote .16261 .16261
High Def (HDTV) .34280 .34280
Extd Def (EDTV) .12228 0
3D Comb. Filter .07122 0
Flat Screen .18461 0
S-Video Input .13722 .13722
DVD Built in .38247 0
Total 7.45836
Now value all the features on a new TV
Price: $1,250Features: 42 inch
PlasmaHigh Definition TVS-Video InputUniversal Remote
Price: $250Features: 27 inch
Cathode Ray TubeEnhanced Definition TVS-Video InputUniversal Remote
Price: $1,537Features: 42 inch
PlasmaHigh Definition TVS-Video InputUniversal Remote
7.45836 5.64208$250 $1,537P e
$1,250 $1,537*100 18%
$1,573
Now, we can add the extra features to the old TV
(Hedonically adjusted)
2003
2003
Potential Problem: What about housing? Consider the following examples:
Option #1: Rent a $240,000 house
Option #2: Buy a $240,000 house with an interest only mortgage (5% per year)
Option #3: Buy a $240,000 house with a 30 year mortgage (5% per year)
$240,000(.05) = $12,000/yr. = $1,000/mo.
$1,288/mo.$1,000/mo.
One of these things is not like the other!
Potential Problem: What about housing? Consider the following examples
Option #1: Rent a $240,000 house
Option #2: Buy a $240,000 house with an interest only mortgage (5% per year)
Option #3: Buy a $240,000 house with a 30 year mortgage (5% per year)
$1,288/mo.
$1,000/mo.
Difference = $288/mo.
OR
What if you put $288/mo. and put it in a savings account that earns 5% per year?
Month Deposit Beginning of Month Balance
Interest End of Month Balance
1 $288 $288 ($288)(.0041) = $1.18 $289.18
2 $288 $577.18 ($577.18)(.0041) = $2.37 $579.55
3 $288 $867.55 ($867.55)(.0041) = $3.56 $871.11
4 $288 $1,159.11 ($1,159.11)(.0041) = $4.75 $1,163.86
5 $288 $1,451.86 ($1,451.86)(.0041) = $5.95 $1,457.81
What if you put $288/mo. and put it in a savings account that earns 5% per year? 5%/yr. = (5/12) = .41%/mo.
What do you think your balance would be after 30 years?
Cool, huh!?
Potential Problem: What about housing? Consider the following examples
Option #1: Rent a $240,000 house
Option #2: Buy a $240,000 house with an interest only mortgage (5% per year)
$1,000/mo.OR
(This is pure cost of living)
Option #3: Buy a $240,000 house with a 30 year mortgage (5% per year)
$1,288/mo.
(This is cost of living plus investment in an asset)
In 1983, the BLS decided to focus entirely on rental markets for housing.
Housing Prices Housing Inflation
Average Inflation Rate
Home Price Index: 4.40%Rental Index: 4.01%
Can you spot the housing bubble?
An alternative to the consumer price index is the GDP Deflator.
Good Production (2014) Current Price (2014) Current Value
Housing 300 $550 $165,000
Transportation 500 $350 $175,000
Food 100 $260 $26,000
Apparel 200 $220 $44,000
Total = GDP (Current Dollars) $410,000
Suppose we have the following Data
Now, Suppose we revalue current GDP at, say, prices in 2009 (Call this the base year)
Good Production 2009 Price 2009 Value
Housing 300 $500 $150,000
Transportation 500 $300 $150,000
Food 100 $200 $20,000
Apparel 200 $200 $40,000
Total = GDP (2009 Dollars) $360,000
Current value of current production (2014)
$410,000 (Current Dollars)
Base year value of current production (Base year = 2009)
$360,000 (2009 Dollars)
We can use these two numbers to construct an implied relative price
$410,000 (Current Dollars)
$360,000 (2009 Dollars)= 1.14 (or, 114)
Note that the base year (2009) is 1 (or, 100) by definition
ln 114 ln 100*100 2.62%
5
Note that the price index is still a weighted average of individual relative prices
Good Production (2014) 2009 Price 2009 Value 2014 Price
Housing 300 $500 $150,000 $550
Transportation 500 $300 $150,000 $350
Food 100 $200 $20,000 $260
Apparel 200 $200 $40,000 $220
Total = GDP (2009 Prices) $360,000
$150,000.41
$360,000
Housing Share of Real GDP
$150,000.41
$360,000
Transp. Share of Real GDP
$20,000.06
$360,000
Food Share of Real GDP
$40,000.12
$360,000
Apparel Share of Real GDP
$550 $350 $260 $220.41 .41 .06 .12 1.14
$500 $300 $200 $200P
(Or, 114)
Good Production (2013) 2009 Price 2013 Price
Housing 280 $500 $535
Transportation 490 $300 $310
Food 105 $200 $240
Apparel 170 $200 $216
$363,620
$342,000= 1.06 (or, 106)
Suppose we repeat for a different year to calculate an inflation rate
$140,000.41
$342,000
Housing Share of Real GDP
$147,000.43
$342,000
Transp. Share of Real GDP
$21,000.06
$342,000
Food Share of Real GDP
$34,000.10
$342,000
Apparel Share of Real GDP
$535 $310 $240 $216.41 .41 .06 .12 1.06
$500 $300 $200 $200P
(Or, 106)
ln 114 ln 106 *100 7.27% Index Inflation
Value of GDP at 2013 Prices
Value of GDP at 2009 Prices
Good 2013 Price 2014 Price Inflation
Housing $535 $550 2.76%
Transportation $310 $350 12.10%
Food $240 $260 8.00%
Apparel $216 $220 1.83%
Now, the inflation rate incorporates price changes as well as expenditure share changes – a lot like the chained CPI!
$140,000.41
$342,000
Housing Share of Real GDP
$147,000.43
$342,000
Transp. Share of Real GDP
$21,000.06
$342,000
Food Share of Real GDP
$34,000.10
$342,000
Apparel Share of Real GDP
2013
2014
$150,000.41
$360,000
Housing Share of Real GDP
$150,000.41
$360,000
Transp. Share of Real GDP
$20,000.06
$360,000
Food Share of Real GDP
$40,000.12
$360,000
Apparel Share of Real GDP
The GDP deflator is an example of a variable weight index
Average Inflation: 3.20%
GDP Def.
GD
P D
efla
tor
2009 = 100
The GDP Deflator: 1948 - 2014
Inflation Rate
Inflation with the GDP Deflator versus the CPI
Average Inflation
CPI: 3.55%GDP Def.: 3.20%
Let’s enlarge this area
What’s going on here?
Average Inflation
CPI: 2.30%GDP Deflator: 2.01%
Inflation with the GDP Deflator versus the CPI
Recall that a large portion of our oil is imported and is therefore not a part of GDP. Which means its not a part of the GDP deflator!
The “core CPI” removes food and energy prices due to their excessive volatility.
Average Inflation
CPI: 2.30%Chain CPI: 2.06%GDP Deflator: 2.01%Core CPI: 1.95%
Lets plot out GDP over a few years. Notice the “saw tooth” pattern?
Retail sales follows a seasonal cycle with lows in January/February and September/October and Highs in May/June and December. This seasonality in sales creates seasonal cycles in most macro series.
Retail Sales (Seasonally Adjusted)
255000
275000
295000
315000
335000
355000
NSA SA
Seasonally adjusting is a process that removes the seasonal components.
9000
9500
10000
10500
11000
11500
12000
12500
Gross Domestic Product
GDP(NSA)
GDP(SA)
In 2002(Q1), GDP is $10,064B while Seasonally adjusted GDP is $10,333B
Lets take a look at the US economy from 1957 to 2008 …
0.0
2000.0
4000.0
6000.0
8000.0
10000.0
12000.0
14000.0
16000.0
Jan-57 Jan-67 Jan-77 Jan-87 Jan-97 Jan-07
GDP (Billions of Dollars)
$14.2T (2008Q1)
$457.2B (1957Q1)
%73.651/100*2.457200,14 LNLN
Comparing GDP in 1957 and 2008 is like comparing apples and oranges. Prices were much different 51 years ago!!
Year Price Level (CPI)
1957 30.0
1983 100.0
2000 180.0
2008 213.3
$14,200B (2008Q1)
$457.2B (1957Q1)
Let’s “scale up” GDP in 1957 and “scale down” GDP in 2008 to reflect year 2000 prices…
18030
180213
=$2,743.2B
=$11,983.12B
Now, these numbers are comparable!
We have now converted GDP to real GDP (2000 prices)
0.0
2000.0
4000.0
6000.0
8000.0
10000.0
12000.0
14000.0
16000.0
Jan-57 Jan-67 Jan-77 Jan-87 Jan-97 Jan-07
GDP (Billions of 2000 Dollars)
$14,200B (2008Q1)
$457.2B (1957Q1)
Lets convert all the years…
$11,983B
$2,743.2B
We have now converted GDP to real GDP (2000 prices)
0.0
2000.0
4000.0
6000.0
8000.0
10000.0
12000.0
14000.0
16000.0
Jan-57 Jan-67 Jan-77 Jan-87 Jan-97 Jan-07
Real GDP (Billions of 2000 Dollars)
$11,983B
$2,743.2B
Note that “Real” GDP crosses GDP at the year 2000
$14,200B (2008Q1)
$457.2B (1957Q1)
Now that we have real GDP, let’s think about the trend…
0.0
2000.0
4000.0
6000.0
8000.0
10000.0
12000.0
14000.0
Jan-57 Jan-67 Jan-77 Jan-87 Jan-97 Jan-07
Real GDP (Billions of 2000 Dollars)
$2,743B
$11,983B
Would a linear trend fit this data (constant dollar growth in GDP)
Exponential growth is constant annual percentage growth
y = 2371.3e0.008x
0.0
2000.0
4000.0
6000.0
8000.0
10000.0
12000.0
14000.0
1 13 25 37 49 61 73 85 97 109 121 133 145 157 169 181 193
Real GDP (Billions of 2000 Dollars)
$2,743B
$11,983B
%89.251/100*743,2983,11 LNLN
Average quarterly growth rate
The previous slide uses an exponential trend. This assumes that the US has some constant annual rate of real economic growth (3.2% per year). Note that actual growth varies even over long time periods.
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
1957-1967 1967-1977 1977-1987 1987-1997 1997-2007 2007-2013
Notice the downward trend in growth…we’ll talk about that later!
Over five year periods, we see that growth seems to have a cyclical pattern rather than a constant annual rate.
0
1
2
3
4
5
6
The Hodrick-Prescott (HP) filter allows us to calculate a trend rate of growth that is not constant.
The HP filter applies a minimization problem…pretty ugly, huh?!
Squared deviations between series and trend
Smoothness of trend
Smoothing parameter (bigger numbers create smoother trends) – usual value = 1600
Here we have annualized growth rates of the HP trend and the Exponential trend
Why is getting the trend right so important?
Time
GDPTrend
Lets imagine enlarging a portion of our GDP graph with a trend. We can see a distinct set of stages…
Negative growth
Above trend growth
Trend Growth
Below Trend Growth
This is what we mean by the business cycle
Time
GDP
Trend
Removing the trend involves subtracting out the trend component from GDP
t
100*%
ttrend
ttrendtGDPDev
-2.00
-1.50
-1.00
-0.50
0.00
0.50
1.00
1.50
2.00
2000
-I
2000
-II
2000
-III
2000
-IV
2001
-I
2001
-II
2001
-III
2001
-IV
2002
-I
2002
-II
2002
-III
2002
-IV
2003
-I
2003
-II
2003
-III
2003
-IV
2004
-I
2004
-II
2004
-III
2004
-IV
% D
evi
ati
on
Recession
100* %
Trend
TrendValueDeviation
Expansion
Peak
Trough
Removing the trend leaves us with the business cycle.
Here, we are plotting percentage deviation of GDP from a HP trend%
Dev
iatio
n fr
om tr
end
We have had 11 cycles since WWII
Business Cycle Dates Duration (In Months)
Peak Trough Contraction (peak to trough)
Expansion (Previous trough to this peak)
Cycle (Peak from previous peak)
August 1929 March 1933 43 21 34
May 1937 June 1938 13 50 93
Feb 1945 Oct 1945 8 80 93
Nov 1948 Oct 1949 11 37 45
July 1953 May 1954 10 45 56
Aug 1957 April 1958 8 39 49
April 1960 Feb 1961 10 24 32
Dec 1969 Nov 1970 11 106 116
Nov 1973 March 1975 16 36 47
Jan 1980 July 1980 6 58 74
July 1981 Nov 1982 16 12 18
July 1990 March 1991 8 92 108
March 2001 Nov 2001 8 120 128
December 2007 June 2009 18 73 81
Average 13 55 69
The US has had 13 Cycles since the great depression