macro ―refresh‖ course: introductiondibartolomeo.comunite.it/courses/macrophd/bcycle.pdf ·...

Macro ―refresh‖ course Economics PhD 2012/13

Macro ―refresh‖ course: Introduction

Giovanni Di Bartolomeo

[email protected]

Note: These lecture notes are incomplete without having attended lectures


Some Key Questions of Macroeconomics

• Why do incomes grow? Why are some countries

richer than others? Why do some grow faster than

others?

• Why do incomes fluctuate? Can policy do anything

about it?

• Why is there unemployment? Is it a necessary part of

economic life? How is it affected by policy?

• What determines inflation?


To address these questions we need to know…

• How individuals behave (―microfoundations‖)

• How individuals interact (―market structure‖)

• How government enters the picture (both the

feasibility of policy and the incentives facing policy

makers)


Methodology

• Models embody assumptions about individual

behavior, market structure and what is exogenous

(including policy regime).

• Solution gives us the endogenous variables in

terms of the exogenous factors.

• Models should be simple and focus on issue at hand.

Do not need to be ―realistic‖, but should be consistent

with the facts.

• Can switch between models according to context; no

grand ―true‖ model.


Stocks vs. Flows - examples

the Government

Budget Deficit

the Government

Debt

# of new college

graduates this year

# of people with

college degrees

a person’s

annual saving a person’s wealth

flow stock

Capital Investment


Real vs. Nominal Variables

• GDP is the value of all final goods and

services produced.

• Nominal GDP measures these values using

current prices.

• Real GDP measure these values using the

prices of a base year.

• Always (YR real var, YN nominal var, P price)

YR = YN/P

YN=YR P


Common Strands:

• Individuals and firms optimize

• Rational Expectations in the long run

• Prices flexible in the long run

Also frequently:

• Perfect Competition: May be unrealistic, but often a

useful simplification


Important Concepts…

• Gross Domestic Product (GDP)

• Components of GDP

• Gross National Product (GNP)

• Price Indices:

GDP Deflator

The Consumer Price Index (CPI)

• The Unemployment Rate


Aggregate Output

• National income and product accounts are an

accounting system used to measure of aggregate

economic activity.

• The measure of aggregate output in the national

income accounts is gross domestic product, or

GDP.

• In the United States, the Bureau of Economic

Analysis calculates GDP and components of the

National Accounts.


GDP: Production and Income

There are three ways of defining GDP: 1. GDP is the value of the final goods and services produced in

the economy during a given period.

A final good is a good that is destined for final consumption.

An intermediate good is a good used in the production of

another good.

2. GDP is the sum of the incomes in the economy during a

given period.

3. GDP is the sum of value added in the economy during a

given period.

Value added equals the value of a firm’s production minus the value of

the intermediate goods it uses in production.


GDP: Expenditure and Income

For first two definitions:

Total expenditure on domestically-produced

final goods and services.

Total income earned by domestically-located

factors of production.

Expenditure equals income because

every dollar spent by a buyer

becomes income to the seller.


The Circular Flow

Households Firms

Goods

Labor

Expenditure ($)

Income ($)


The Expenditure Components of GDP

• Consumption

• Investment

• Government spending

• Net eXports


An important identity

Y = C + I + G + NX

Aggregate

Expenditure Value of

Total

Output


The Components of GDP

• Consumption: Approximately 70% of US GDP

• Investment: 20% of GDP

• Government Consumption: 15.8% of GDP

• Exports: 11% of GDP

• Imports: 16.9% of GDP


The Business Cycle

Giovanni Di Bartolomeo

[email protected]

Note: These lecture notes are incomplete without having attended lectures


The Business Cycle

• What is a Business Cycle?

The business cycle is the periodic but irregular up-and-down movement in production and jobs.

• The NBER defines the phases and turning points of the business cycle as follows:

A recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade.

A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion.


Economic Growth and Fluctuations

Every business cycle has two phases:

1. A recession

2. An expansion

and two turning points:

1. A peak

2. A trough

• A recession is a period during which real GDP

decreases for at least two successive quarters.

• An expansion is a period during which real GDP

increases.



• Economic Growth in the United States

Figure 1 on the right shows real GDP in the United States from 1962 to 2007.

• The figure highlights: Fluctuations of real GDP

Smoother growth of potential GDP

Real GDP Potential

GDP

Source: Bureau of Economic Analysis



• Potential GDP is the value of real GDP when all the economy’s labour, capital, land, and entrepreneurial ability are fully employed.

• During the 1970s and early 1980s, real GDP growth slowed—a productivity growth slowdown.

Real GDP Potential

GDP

The long term

growth rate is …

… 4.4 percent

per year

… 2.9 percent

per year

… 3.1 percent

per year

… 2.8 percent

per year

Source: Bureau of Economic Analysis



• Real GDP fluctuates around

potential GDP in a

business cycle

a periodic but irregular

up-and-down movement

in production. Real GDP

Potential

GDP

The long term

growth rate is …

… 4.4 percent

per year

… 2.9 percent

per year

… 3.1 percent

per year

… 2.8 percent

per year



8000

9000

10000

11000

12000

1996-IV 1997-IV 1998-IV 1999-IV 2000-IV 2001-IV 2002-IV 2003-IV 2004-IV 2005-IV 2006-IV 2007-IV

Real

GD

P (

billio

ns o

f 2000 d

ollars

)

Year

• This figure shows the most recent U.S. cycles.

Real GDP

Potential

GDP Peak

Peak

Trough

Expansion Expansion

Recession


23


• This figure shows the long-term growth trend and cycles


Production (Real GDP) as a Benchmark

• In Macroeconomics, we compare what happens to

different variables in terms of how it relates to

production in the economy (i.e. how does inflation, or

unemployment relate to real GDP?)

• Definition:

Procyclical: the variable moves with the business cycle (i.e.

it increases when production increases and vice versa)

Countercyclical: the variable moves in the opposite

direction of the business cycle (i.e. it increases when

production decreases and vice versa)

Acyclical: does not move with the business cycle


Thinking About Cyclicality…

• As a general rule of thumb:

A variable, X, is procyclical if Correlation(X, output gap) or

Correlation (X, economic growth rate) > 0.25

A variable, X, is countercyclical if Correlation(X, output gap)

or Correlation (X, economic growth rate) < -0.25

A variable, X, is acyclical if -0.25 < Correlation(X, output

gap) < 0.25

• In general the closer the correlation is to +1 ( -1) (i.e.

the further away it is from zero), the greater the

degree of pro-cyclicality (counter-cyclicality).


Some Facts about the Business Cycle

• GDP growth averages 3–3.5 percent per year over

the long run with large fluctuations in the short run.

• Consumption and investment fluctuate with GDP, but

consumption tends to be less volatile and investment

more volatile than GDP.

Correlation of consumption and the output gap: 0.998

Correlation of investment and the output gap: 0.989

• Unemployment rises during recessions and falls

during expansions.

Correlation of unemployment and GDP is approx -0.67

• Okun’s Law: the negative relationship between

GDP and unemployment.


Growth rates of Real GDP, Consumption

-4

-2

0

2

4

6

8

10

1970 1975 1980 1985 1990 1995 2000 2005

Real GDP growth rate

Average growth

rate

Consumption growth rate

Percent

change

from 4

quarters

earlier


Growth rates of Real GDP, Consumption, Investment

-30

-20

-10

0

10

20

30

40

1970 1975 1980 1985 1990 1995 2000 2005

Percent

change

from 4

quarters

earlier

Investment growth rate

Real GDP growth rate

Consumption growth rate


Unemployment

0

2

4

6

8

10

12

1970 1975 1980 1985 1990 1995 2000 2005

Percent

of labor

force

• Unemployment rises in recessions and falls in expansions

• Unemployment rate is a lagging indicator


Okun’s Law

Percentage

change in

real GDP

Change in unemployment rate

-4

-2

0

2

4

6

8

10

-3 -2 -1 0 1 2 3 4

1975

1982 1991 2001

1984

1951 1966

2003

1987

3.5 2

Y

uY

• Okun’s Law:

the negative

relationship

between GDP

and

unemployment.


Output Gap and Productivity

-600

-400

-200

0

200

400

600

1975 1980 1985 1990 1995 2000 2005

Productivity (x100)(Real) Output Gap

Cyclica

l V

ari

atio

n

• The correlation

between productivity

and real GDP is

approximately 0.9996

• This indicates that

productivity is highly

procyclical


Business Cycle Facts (Quantities)

1. Output movements persist (but not periodic)

2. Industries move together

3. Consumption, Investment and Imports are procyclical

they move with the business cycle and this is highlighted by positive correlations

4. Unemployment is countercyclical, but productivity is procyclical


Business Cycle Facts (Prices)

1. Prices/Inflation is procyclical.

2. Real wages are acyclical or mildly procyclical.

3. Short term interest rates are procyclical.

4. Money and velocity are procyclical.


Output Gap and Inflation

-3

-2

-1

0

1

2

3

4

1975 1980 1985 1990 1995 2000 2005

Inflation Rate Output Gap

Pe

rce

nt

• The correlation between

the CPI and GDP is

0.979.


inflation and GDP is

approximately 0.301.


prices are highly

procyclical, whilst

inflation is mildly

procyclical


Inflation v. Output Gap

• This scatter plot highlights

the positive relationship

observed between inflation

and the output gap.

• The bigger output is

(above potential), the

greater the amount of

inflation!

-.01

.00

.01

.02

.03

.04

-.04 -.03 -.02 -.01 .00 .01 .02 .03 .04

Output Gap

Infla

tio

n

US 1973 - 2006


Output Gap and Real Wage


real wages and real GDP is

approximately 0.124

• This indicates that real

wages are acyclical (– i.e.

that they are independent of

the business cycle) or at

best, very mildly procyclical. -3

-2

-1

0

1

2

3

1975 1980 1985 1990 1995 2000 2005

(Real) Output Gap Real Wage

No

rma

lize

d V

ari

ab

les


Real Wage v. Output Gap

0.96

1.00

1.04

1.08

1.12

1.16

-300 -200 -100 0 100 200 300

(Real) Output Gap

Re

al W

ag

e

US 1973 - 2006

• This scatter plot

highlights the lack of a

relationship between

real wages and the

output gap.

• It is not possible to

figure out which

direction the line of

best fit should go!


Output Gap and Short Interest Rate

• The correlation

between short term

interest rates and GDP

is approximately 0.401


nominal interest rates

are procyclical 0

4

8

12

16

20

24

28

32

-.04

-.03

-.02

-.01

.00

.01

.02

.03

.04

1975 1980 1985 1990 1995 2000 2005

Federal Funds Rate Output Gap

Inte

rest R

ate

(P

erc

en

t)

Cyclic

al V

aria

tion


Output Gap and Real Short Interest Rate

-4

0

4

8

12

16

20

-300

-200

-100

0

100

200

300

1975 1980 1985 1990 1995 2000 2005

Real Fed Funds Rate(Real) Output Gap

Re

al F

ed

Fu

nd

s R

ate

(P

erc

en

t)

Cyclic

al V

aria

tion

• The correlation

between short term

interest rates and Real

GDP is approximately

0.384

• This indicates that real

interest rates are

(mildly) procyclical


Output Gap and Money Supply

-8

-4

0

4

8

12

65 70 75 80 85 90 95 00

Money Supply Output Gap

Perc

en

t

US 1965-2001

• The correlation

between money supply

and GDP is

approximately 0.967

• This indicates that the

money supply is highly

procyclical


Output Gap and Velocity

-10

-5

0

5

10

65 70 75 80 85 90 95 00

Velocity Output Gap

Perc

en

t

US 1965-2001

• The correlation

between velocity and

GDP is approximately

0.826


velocity is highly

procyclical

macro ―refresh‖ course: introductiondibartolomeo.comunite.it/courses/macrophd/bcycle.pdf ·...

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