Week 1

Lectures 1 & 2

Measuring Macroeconomic Performance: Output and Prices Reference: Bernanke, Olekalns and Frank (BOF) Chapter 1 Key Issues Indicators of macroeconomic performance Measuring output (GDP) Measuring prices and inflation

Evaluating Macroeconomic Performance 1. Rising Living Standards economic growth Tendency for the level of output (i.e. quantity and quality of goods and services) to increase over time. Output divided by population = output per capita May also care about the distribution of living standards

$ per qtr 10000 11000 12000 13000 14000 15000 16000 6000
Sep-1973 Sep-1974 Sep-1975 Sep-1976 Sep-1977 Sep-1978 Sep-1979 Sep-1980 Sep-1981 Sep-1982 Sep-1983 Sep-1984 Sep-1985 Sep-1986 Sep-1987 Sep-1988 Sep-1989 Sep-1990 Sep-1991 Sep-1992 Sep-1993 Sep-1994 Sep-1995 Sep-1996 Sep-1997 Sep-1998 Sep-1999 Sep-2000 Sep-2001 Sep-2002 Sep-2003 Sep-2004 Sep-2005 Sep-2006 Sep-2007 Sep-2008 Sep-2009 Sep-2010

Real Quarterly GDP per-capita Australia (1973-2011)

7000

8000

9000

2. Stable Business Cycle low volatility in fluctuations of actual output around its trend or potential output. Australias Real Quarterly GDP Growth Rates Decade Averages 1960s 1970s 1980s 1990s 2000s Mean 1.26 0.78 0.82 0.83 0.75 Standard 1.50 1.49 0.97 0.77 0.52 Deviation Ratio 0.84 0.53 0.85 1.08 1.44 Mid-1980s Great Moderation large fall in volatility of real output why?
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3. Relatively Stable Price Level low (positive) rate of inflation Inflation has been concern for most developed countries over the last 40 years. Japan is an exception and has experienced deflation over the last decade.

Year-ended % change 10.0 12.0 14.0 16.0 18.0 20.0 0.0 2.0 4.0 6.0 8.0 -2.0 Sep-1970 Oct-1971 Nov-1972 Nov-1973 Nov-1974 Nov-1975 Nov-1976 Nov-1977 Nov-1978 Nov-1979 Nov-1980 Nov-1981 Nov-1982 Nov-1983 Nov-1984 Nov-1985 Nov-1986 Nov-1987 Nov-1988 Nov-1989 Nov-1990 Nov-1991 Nov-1992 Nov-1993 Nov-1994 Nov-1995 Nov-1996 Nov-1997 Nov-1998 Nov-1999 Nov-2000 Nov-2001 Nov-2002 Nov-2003 Nov-2004 Nov-2005 Nov-2006 Nov-2007

Australian Inflation - Consumer Price Index Measure

4. Sustainable Levels of Public and National Debt Public debt borrowing by public sector from private sector Influenced by government budget deficits/surpluses Foreign debt borrowing by domestic residents from foreign countries Influenced by an economys current account deficits/surpluses

Budget Balance and Net Government Debt for Australia

2013-15

2013-14

2012-13

2011-12

2010-11 Net Debt

2009-10

2008-09

2007-08 Budget Balance

2006-07

2005-06

2004-05

2003-04

2002-03

2001-02

2000-01 8 6 4 2 0 -2 -4 -6

Australias Net External Liabilities

70.0 60.0 50.0
Per cent

40.0 30.0 20.0 10.0 0.0

Jun-88 Jun-90 Jun-92 Jun-94 Jun-96 Jun-98 Jun-00 Jun-02 Jun-04 Jun-06 Jun-08

Net Debt/GDP

Net Equity/GDP

Net External Liabilities/GDP

5. Balance between Current and Future Consumption How much should an economy save/invest?

10

Australian Private Investment and National Saving

30.00 25.00

% of GDP

20.00 15.00 10.00 5.00 0.00

Sep-76

Sep-78

Sep-80

Sep-82

Sep-84

Sep-86

Sep-88

Sep-90

Sep-92

Sep-94

Sep-96

Sep-98

Sep-00

Sep-02

Sep-04

Sep-06

National Saving/GDP

Private Investment/GDP

Sep-08
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6. Full Employment Provision of employment for all individuals seeking work

12

Percent
10.0 12.0 0.0 Feb-1978 Jan-1979 Dec-1979 Nov-1980 Oct-1981 Sep-1982 Aug-1983 Jul-1984 Jun-1985 May-1986 Apr-1987 Mar-1988 Feb-1989 Jan-1990 Dec-1990 Nov-1991 Oct-1992 Sep-1993 Aug-1994 Jul-1995 Jun-1996 May-1997 Apr-1998 Mar-1999 Feb-2000 Jan-2001 Dec-2001 Nov-2002 Oct-2003 Sep-2004 Aug-2005 Jul-2006 Jun-2007 May-2008 Apr-2009 Mar-2010 Feb-2011 2.0 4.0 6.0 8.0

Australian Unemployment Rate Monthly

13

Measuring National or Aggregate Output GDP Gross Domestic Product Definition: The market value of final goods and services produced in a country during a given period.

14

The market value of final goods and services produced in a country during a given period. GDP is a flow variable measured over a period of time. Quarter March, June, September, December Australian GDP in March 2011 = $347.0 billion Year just add-up GDP over 4 quarters Calendar Mar-09 + Jun-09 + Sep-09 + Dec-09 Financial Sep-09 + Dec-09 + Mar-10 + Jun-10
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The market value of final goods and services produced in a country during a given period. GDP is measure of aggregate production or output Use market prices to value (or weight) quantities of various goods and services Example: Quantity 10 cars 100 apples Market Price $20,000 per car $1 per apple

GDP = $200,000 + $100 = $200,100

16

What about goods and services with no observed market price? Some are included in GDP: National defense use costs of provision (costs of buying equipment, wages of soldiers, etc.) Some are excluded from GDP Unpaid housework

17

The market value of final goods and services produced in a country during a given period. GDP excludes intermediate goods and services. These goods are used-up in the production process. Example: In the production of a loaf of bread, the flour used is an intermediate input and is not counted in GDP. Concept of Value Added: The market value of a firms production less the cost of inputs purchased from other firms

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Value Added in Computer Sales: Chapter 1, Problem 2 (Textbook) Firm Intel Incorp Macro Soft Bell PC Charlies Sales Cost of inputs Value Added 20,000 0 20,000 5,000 0 5,000 80,000 25,000 55,000 100,000 80,000 20,000

PC Charlies final sales = $100,000 Sum of Value Added = $100,000

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3 Ways to Measure GDP 1. Production Method 2. Expenditure Method 3. Income Method

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Expenditure Method Accounting Identity Expenditure on goods and services by final users must equal the value of their production. Components of Expenditure Consumption (C) purchases by Households Investment (I) purchases by Firms Government (G) Government purchases Net Exports (NX ) net purchases by foreign sector NX = Exports Imports
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National Income Accounting Identity GDP=Expenditure Y = C + I + G + NX

22

Australian GDP March Quarter 2011 Expenditure Approach $billion 185.3 74.7 83.0 0.7 71.8 68.7 346.8 0.2 347.0
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Household Consumption Private Investment Government (Public) Spending Change in Inventories Exports Less Imports Total Statistical discrepancy GDP

Income Method GDP also equals the aggregate incomes paid to Labour (L) Capital (K) in the production of goods and services.

GDP = Labour Income + Capital Income

24

Australian GDP March Quarter 2011 Income Approach $ Billion 168.3 117.6 27.2 313.0 33.4 346.4 0.6 347.0
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Compensation of Employees Gross Operating Surplus Gross Mixed Income GDP (at factor cost) Taxes Subsidies GDP (Market Prices) Statistical discrepancy GDP

Nominal vs. Real GDP Nominal values quantities of goods and services produced at current year prices

Real values quantities of goods and services produced at base year prices measure of the actual physical volume of production

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Example No. of Cars Price of Cars No. of Apples Price of Apples Nominal GDP Real GDP 2007 prices 2008 prices 2007 10 $20,000 100 $1 $200,100 2008 % Change 10 0 $40,000 100 100 $2 $400,200 0 100 100

$200,100 $400,200

$200,100 $400,200

0 0
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Choice of Base Year (Bit Technical) In the above example whether we use 2007 or 2008 as base year prices gives the same answer for the growth rate of real GDP This is not the case in general, particularly if you are comparing real GDP over a 5-10 year period. Using initial prices (i.e. 2007) is know as a Laspeyres index Using final prices (i.e. 2008) is known as a Paasche index
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Chain Weighting For any two consecutive years compute the growth rates of real GDP implied by both the Laspeyres and the Paasche indexes. Then take the average of the two growth rates and this is the chain-weighted growth rate. This can be used to compute a real chained-weighted GDP. Finally to compute a change index over a long period, the above approach is applied on a year-by-year basis.

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Example No. of Cars Price of Cars No. of Apples Price of Apples Nominal GDP Real GDP 2007 prices 2008 prices

2007 10 $20,000 100 $10 $201,000 $201,000 $402,500

2008 % Change 10 0 $40,000 100 1000 $25 $425,000 $210,000 $425,000 900 150 111 4.5 (L) 5.6 (P)
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Chain-weighted measure of Real GDP Take average of growth rates implied by 2007 and 2008 prices. 5.05% = (4.5% + 5.6%)/2 Choose either 2007 or 2008 as the base-year (nominal=real GDP). Lets pick 2007 2007 Nominal GDP 201,000 Real GDP 201,000 2008 425,000 211,151 (=201,0001.0505)

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Is GDP A Good Measure of Economic Wellbeing? Some Omissions Leisure Time Household production Environmental Degradation Quality of Life Economic Inequality It is likely that GDP is positively related (correlated) with economic wellbeing Variety of goods and services Health and Education

32

Measures of the Price Level Want to measure the average level of prices in the economy. Main Measures Consumer Price Index (CPI) GDP Deflator/Price Index CPI For a given period, measures the cost in that period of a given basket of goods and services relative to their cost in a fixed year called a base year.
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Construct a CPI Choose a basket of goods and services Basket 2000 (base) Rent (2 bedroom flat) $500 Hamburgers (60) $150 CDs (2) $30 Total Expenditure $680

2008 $630 $150 $70 $850

CPI = Cost of base-year basket of goods and services in current year Cost of base-year basket of goods and services in base year
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CPI = $850/$680 = 1.25 Cost of living is 25 percent higher in 2008 than it was in 2000 Average prices are 25 percent higher in 2008 than in 2000 Australian CPI Published quarterly by ABS Household Expenditure Survey used to determine typical basket Base year changes every 5 years

35

Inflation (and Deflation) Inflation is measured by the percentage change in the CPI over a given period. Inflation rate
CPI CPI (1) = [ CPI (1) ] *100

Inflation rate = 0 implies prices are constant Inflation rate > 0 implies prices are rising Inflation rate < 0 implies prices are falling Deflation
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Limitations with CPI Quality Adjustment and New Goods Bias Quality improvements may show up as higher prices for goods and services New goods are often not included until CPI is rebased Substitution Bias Use of a fixed basket means that no allowance is made for consumers substitution toward relatively less expensive goods. CPI tends to overstate the rate of inflation.
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Costs of Inflation Important to distinguish between relative price change and a change in the general price level Shoe-leather costs inflation reduces the real purchasing power of a given amount of money Menu costs real costs of changing prices Introduces noise into the price mechanism Distorts tax systems (if not indexed to inflation) Unexpected re-distributions of wealth

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Inflation and Interest Rates Nominal Interest Rates percentage increase in the nominal (or dollar) value of a financial asset. Real Interest Rate percentage increase in the real purchasing power of a financial asset.

r = i
r = real interest rate i = nominal interest rate = inflation rate

39

Inflation and Interest Rates

24

Fisher Effect Nominal interest rate = real rate + (expected) inflation rate

i = r +

40

Inflation and Nominal Interest Rate

16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 -2.0

% per annum

Mar-86

Mar-88

Mar-90

Mar-92

Mar-94

Mar-96

Mar-98

Mar-00

Mar-02

Mar-04

Mar-06

Inflation (year-ended)

10 Year Bond Rate

Mar-08

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