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Analyzing the Real Analyzing the Real SectorSector

OverviewJan Gottschalk

TAOLAM

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Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”

December 16-20, 2013 Yangon, Myanmar

I. Growth

OverviewOverview

II. GDPIII. InflationIV. Nominal vs. RealV. Forecasting GDP

1. Forecasting Real GDP2. Forecasting Inflation3. GDP Deflator4. Putting It Together: Nominal GDP Forecasts

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I. GrowthI. GrowthThe Long View

Figure: Evolution of GDP 1000-2000



Economic Growth and Income DifferencesEconomic Growth and Income Differences

Figure: The evolution of income per capital 1960-2000

3



GDP Growth at Constant Prices, per Capita GDP Growth at Constant Prices, per Capita GDP Growth per Capita (Constant LCU, Change in %)

Economic Growth inEconomic Growth in Myanmar & ThailandMyanmar & Thailand

-5%

0%

5%

10%

15%

MyanmarThailand

-15%

-10%

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

2008

2012



GDP at Constant Prices, per Capita GDP at Constant Prices, per Capita GDP per Capita (Constant LCU, 1960=100)

200 0300.0400.0500.0600.0700.0800.0900.0

1,000.0

MyanmarThailand

0.0100.0200.0

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

2010

4



Compare GDP at Current Prices, US Compare GDP at Current Prices, US dollars, per Capita :dollars, per Capita :

GDP per Capita in US Dollars

2 000

3,000

4,000

5,000

6,000

GDP per Capita in US Dollars

MyanmarThailand

0

1,000

2,000

2009 2010 2011



Growth and Business CyclesGrowth and Business Cycles

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How do we explain growth?How do we explain growth?

Laborof

tion

CapitalPhysical

Human

Fact

ors

Prod

uct

ProductivityTechnology

Institutions



Sources of GrowthSources of Growth——Innovation of Technology Innovation of Technology & Products& ProductsInnovation is a broad

t iconcept, encompassing adoption of best practices, new technology, and developing new products. It is also a search process with many failures and few small successes that move the economy forward.

6



Market Economy Fosters Innovation & Growth Market Economy Fosters Innovation & Growth But Is ComplexBut Is ComplexPrices are key coordination mechanism for a market economy;price stability works best in context of

imacroeconomic stability.



Price Signals are Central for Market Economy Price Signals are Central for Market Economy But Easily Washed OutBut Easily Washed OutPrice mechanismPrice mechanism works best against a background of stable prices, i.e., low inflation and stable exchange rate.

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IMF Research Results on Growth FactorsIMF Research Results on Growth Factors



Investment is associated with Investment is associated with higher growth …higher growth …

Real Investment (percent of GDP)25 p

10

15

20

LICs with strong growthLICs with weak gro th

0

5

t [–4,0] t [1,5]* t [6,10]**

growth

8



… and FDI appears to be especially beneficial… and FDI appears to be especially beneficial

Net Foreign Direct Investment gFlows

(percent of GDP)

2

3

4

LICs with strong growthLICs with weak

0

1

t [–4,0]*** t [1,5]* t [6,10]**

growth



Growth takeoffs are associated with opennessGrowth takeoffs are associated with openness

Real Exports (percent of GDP)

1520253035


05

10

t [–4,0] t [1,5] t [6,10]**

LICs with weak growth

9



Reining in high inflation promotes growthReining in high inflation promotes growth

25

10

15

20

25


Inflation (1990-2011)

0

5

t [–4,0]*** t [1,5] t [6,10]**

growth



II. GDP II. GDP

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Measure of output

Why Is GDP so Important?

• Measure of output• Approximation of welfare• Many other variables are moving broadly

proportional to GDP (e.g., revenues) GDP ratios GDP forecast is basis for revenue forecasts etc.M i k i GDP hl• Macroeconomic management: keeping GDP roughly in line with its potential



Gross output: value of all goods produced in the economy (double counting; example of wheat used in

What is GDP and How Do We Measure It?

economy (double counting; example of wheat used in production of bread)

Value added (VA): gross output minus intermediate consumption (eliminates double counting)

Gross Domestic Product (GDP): sum of value added across all sectors of the economy. Measures the value of final goods and services

Consumption: can be intermediate (inputs into production) and final (goods and services used byproduction) and final (goods and services used by households and government sector)

Gross investment (also called gross capital formation): additions to the physical stock of capital in the economy, such as building of machinery, facilities

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Goods and services (real flo

Estimate of GDP

Production ApproachMoney (financial flow) ( sectoral "value added") 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)

OS=gross operating surpluses of enterprises (including profits, rents, interests)

Labor (real flow) TSP=taxes less subsidies



Production Approach: GDP SharesProduction Approach: GDP SharesComposition of GDP (Constant 2006/07 Prices)

5%10%15%20%25%30%35%40%45%50%

Agriculture

Mining and Energy

Industry & construction

0%5%

2005/06

2006/07

2007/08

2008/09

2009/10

2010/11

2011/12

Services and trade

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Growth by SectorGrowth by Sector

GDP Growth (Constant 2006/07 Prices)

5%

10%

15%

20%

25%GDP Growth (Constant 2006/07 Prices)

GDP (constant 2006/07 prices)Agriculture

Mining and Energy

0%

5%

2005/06

2006/07

2007/08

2008/09

2009/10

2010/11

2011/12Industry & constructionServices and trade



GDP Growth Contributions by SectorGDP Growth Contributions by SectorGDP Growth (Constant 2006/07 Prices)

4%

6%

8%

10%

12%

14%

Services and trade

Industry & constructionMining and Energy

0%

2%

2005/06

2006/07

2007/08

2008/09

2009/10

2010/11

2011/12

Agriculture

GDP (constant 2006/07 prices)

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Absorption (A) Final Consumption (C) +

GDP from the Expenditure Side

Absorption (A) = Final Consumption (C) + Investment (I): A = C + I

Net Exports (X-M)X = Exports of goods and servicesM = Imports of goods and servicespo ts o goods a d se ces

GDP = A + X – MDomestic Demand Foreign Demand



Final consumption (C)Households: food electricity cars mobile phones

GDP from the Expenditure Side—Examples:

Households: food, electricity, cars, mobile phones, etc.Government: ‘goods & services’ in recurrent budget both imported & locally produced goods Investment (I)

Machines, equipment both imported & locally produced goods

Exports (X)Exports (X)garments, rice, jade etc. Imports (M)

Cars, mobile phones, machines, equipment (see above)

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3030

Main Exports(In percent of GDP)

10

15

20

25

30

10

15

20

25

30Food Gas

Garments Wood

Other Total Exports

0

5

0

5

2008 2009 2010 2011 2012



Inflation is a sustained increase in the overalli l l

III. InflationIII. Inflation

price level◦ Increase in average prices of all goods and services vs.

change in relative prices of individual goods and services◦ One-time increase in the price level vs. underlying inflation

Commonly used measures include changes in:y g− The consumer price index (CPI)− Wholesale (WPI) oror Producer Price Index (PPI)− The GDP deflator (PGDP)

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Reasonably low inflation is equivalent to price stability

Why Do We Care About Inflation?

stability key element of macroeconomic stability matters for growth

Many macroeconomic variables have a price component, e.g.Nominal GDP Real GDP * GDP DeflatorNominal GDP = Real GDP * GDP Deflator Inflation helps understanding the price component



Inflation DeterminantsInflation Determinants

Π (Price Inflation)

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Nominal GDP: measures the value of output of the economy at current prices

IV. Nominal IV. Nominal vs. Realvs. Real

of the economy at current prices Real GDP: measures the value of output of

the economy -- 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



Distinction Between Nominal & Real Is Useful For (1) Purchasing Power

If inflation was 10%,Real buying power grew

BUT

If inflation was 30%,Real buying power shrank

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Distinction Between Nominal & Real Is Useful For (2) Accounting for Different Determinants

Fundamental relation to be used over & over !

Approximation: ∆%V ≈ ∆%P + ∆%Q

Nominal GDP (V) = GDP Deflator (P) * Real GDP (Q)

Exact relationship:(1+ ∆%V/100) =(1+∆%P/100)*(1+∆%Q/100)



V. Forecasting GDPV. Forecasting GDPWhy does forecasting GDPWhy does forecasting GDPmatter?• GDP forecast is the starting point for many other forecasts, e.g., revenues or imports• Similarly, GDP forecasts are

f j i GDPnecessary for projecting GDP ratios• GDP forecasts are central for macroeconomic management

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It’s difficult …It’s difficult …• It’s very rare that the f hi l hforecast hits exactly the 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 as important



General Procedure• Start with analyzing the

h kpast what were key developments and 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 policy (changes) into account

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Forecasting Real GDP (volume)

Specific Procedure

◦ Potential output and output gap◦ Supply: Production function Sectoral forecasts◦ Demand: expenditures (C + I + X - M)◦ Reconciliation of Supply & Demand Forecasting Inflation (prices) Obtaining Nominal GDP Forecast



V.1 Forecasting Real GDPPotential Output & Output Gap

• Potential GDP is the level of output that can be sustainably produced without adding or subtracting inflation pressures. That is, demand and supply are broadly in balance.

• Output gap: The difference between actual and potential GDP.

• Output gap may be positive or negative. − A positive output gap would signify an expansion that could

place excessive pressure on resources.− A negative output gap signifies idle resources—low capacity

utilization of capital stock and higher unemployment—that is likely to lead to declining rates of inflation or deflation.

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Output Gaps

Positive output gap:demand > supply

Negative output gap:d d ldemand < supply



Q = f (K L A)

Supply Side: Production Function Approach for Forecasting Potential Growth

Q = f (K, L, A)where K = Capital

L = LaborA = Technology, Institutions

In the long run, increasing supply requires increasing A (through structural policies)

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Production Approach to GDP:

Forecast production in each sector separately as they

Supply Side: Sectoral Forecasts

Forecast production in each sector separately as they may have different determinants, then add up the individual forecasts to obtain the total:

...,

1,

,

1,

,

1,1

tser

tserser

tman

tmanman

tagr

tagragr

t

t

GDP

GDPw

GDP

GDPw

GDP

GDPw

GDP

GDP



GDP = (CP + CG) + (IP + IG) + (X – M)Demand Side: Forecasting Expenditure

Fiscal sector BOP

We should be able to forecast public consumption and investment (CG & IG) using information from the budget. We might be able to construct forecast equations for exports and imports (X – M) [External sector]

Fiscal sector BOP

Private consumption (CP) is often fairly steady and not that difficult to forecastLeaves private investment (IP) as a very difficult element to forecast because this tends to be fairly volatile

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V.2 Forecasting Inflation

Why does forecasting inflationWhy does forecasting inflationmatter?• Inflation forecast is the starting point for the price component of many other forecasts, e.g., GDP deflator

K i i fl i d l• Keeping inflation under control is central macroeconomic objective, which requires inflation forecast

The Simplest Inflation ForecastUses only past data on CPI or inflation as input …

R iRequires: Reliable CPI data Basic techniques in

data analysis / Excel skills

Advantage: Simple In the short-term,

hard-to-beat fforecast

Disadvantage: Doesn’t help with

monetary policy formulation

Structural breaks are major problem

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Probably not too

For Myanmar It Could Look Like This …

Trend CPI in Myanmar (Example)bad as a forecast, but …• based on a number of arbitraryassumptions, and• not useful for 50.0

100.0

150.0

200.0

250.0y ( p )

analysis of causes of inflation

0.0 1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

CPI (Index, eop) Trendline



Core vs non-core inflation

Adding Content to the Inflation Analysis—General Considerations

(e.g., non-food vs food inflation) Overall demand conditions Exchange rates Imported prices Expectations

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A Simple Way to Identify Inflation Factors: Decomposition Into Core and Non-Core InflationUses only past data on CPI or inflation and its components as input …

R iRequires: Reliable CPI data

on headline inflation and its components

Basic techniques in data analysis / Excel skills

Advantage:Si l Simple

InformativeDisadvantage: It is still silent on

role of monetary policy for inflation



For Myanmar It Could Look Like This …

10.0%Contributions of Food and Non-Food Inflation

0.0%

2.0%

4.0%

6.0%

8.0%

Non-foodFoodInflation (eop)

-6.0%

-4.0%

-2.0%

2008 2009 2010 2011 2012

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Inflation Forecast: Practical ApproachWhen data is not extensively available --Inertial Approach (with judgmental adjustment): 1t t tX

• How and why would inflation rate be different from the previous year?

X: judgmental adjustment

Expected cost pressures:W ld d i h h i diWorld trade prices, exchange rate changes, wages, indirect taxes

Expected policy and other demand changes:Changes in fiscal or monetary policy stance, slowdown in consumption due to rising unemployment, negative expectations



V.3 GDP Deflator

Real

Consumption =

Nominal Consumption Deflator

=Consumption

Real Investment

Investment Deflator

= Nominal

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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Decomposing GDP deflator into its components

Forecasting GDP Deflator

%∆PGDP = WC %∆PC + WI %∆PI

+ WX %∆PX - WM %∆PM

WC = consumption share in GDP

WI = investment share in GDP

WX = export share in GDP

WM = import share in GDP



Consumption: %∆ PC = %∆ CPI Investment: %∆ PI = (1-a) %∆ CPI + a %∆ PM

Forecasting Component Deflators

Investment: %∆ PI (1 a) %∆ CPI + a %∆ PM

(a = share of imported investment goods)

Export:%∆ PX = ((1+%∆ Export price in US$/100) *(1+%∆ Exchange rate/100) –1) *100

Import:Import:%∆ PM = ((1+%∆ Import price in US$/100) *(1+%∆ Exchange rate/100) –1) *100

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Forecast real GDP growth Forecast prices

V.4 Putting It Together: Nominal GDP Forecast

p◦ CPI◦ Sub-components of GDP deflators (CG, IP , IG)◦ GDP deflator

Compute nominal GDP growth, using

Value = Value (1+%P) (1+%Q)Valuet+1 = Valuet (1+%P) (1+%Q)



CONGRATULATIONS!

You are now well on your way to forecasting GDP and Inflation on

your OWN!

Thank you!

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