Lecture 4: Basics Of Macroeconomics I

Given to theGiven to theEMBA 8400 ClassEMBA 8400 ClassBuckhead CenterBuckhead Center

April 3, 2010April 3, 2010

Dr. Rajeev DhawanDr. Rajeev DhawanDirectorDirector

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)

138

11108

1011166

16

8

5080374539

24106365812

92

6388485547

34117526428

100

9393455649

32116477418

108

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

NBER Report Cycle Dates 2003

Article: Business CyclesArticle: Business Cycles

Forecast of the Nation, 2003

Mar 01’ ~ Nov 01’ 9 -0.1% -4.0% 4.2 5.6

200420001996199219881984198019761972196819641960

12000

10000

8000

6000

4000

2000

0

(Bil. 2000$)Real GDP and Business Cycles

200420022000199819961994199219901988

11000

10000

9000

8000

7000

6000

(Bil. 2000$)Real GDP and Business Cycles

20052004200320022001200019991998

118

116

114

112

110

108

106

104

102

134

132

130

128

126

124

(Index: 1997=100) (Mil.)Industrial Production and Employment

Industrial Production Total Payroll Employment

DECAUGAPRDECAUGAPRDECAUGAPRDECAUGAPRDECAUG20042003200220012000

320

310

300

290

280

270

260

250

(Bil.)Retail Sales

NOVJULMARNOVJULMARNOVJULMARNOVJULMARNOVJULMARNOVJUL200420032002200120001999

6

5

4

3

2

1

0

(%)

Real Disposable Income GrowthOn a Percent Change from a Year Ago Basis

NOVJULMARNOVJULMARNOVJULMARNOVJULMARNOVJUL20042003200220012000

8

6

4

2

0

-2

-4

-6

(%)

Real Retail Sales GrowthOn a Percent Change from a Year Ago Basis

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

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

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

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

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 Consumer Price Index and the Inflation Rate: An Example

Calculating the Consumer Price Index and the Inflation Rate: An Example

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

4%

42%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

1965

Percentper Year

15

CPI

GDP deflator

10

5

01970 1975 1980 1985 1990 20001995

2006200219981994199019861982

10

8

6

4

2

0

-2

-4

(%)

Japan - GDP Growth and Deflator(smoothed)

Real GDP Growth Nominal GDP Growth GDP Deflator

20062004200220001998199619941992

10

8

6

4

2

0

-2

(%)

Germany - GDP Growth and Deflator(smoothed)

Real GDP Growth Nominal GDP Growth 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

1965

Interest Rates(percentper year)

15%

Real interest rate

10

5

0

-51970 1975 1980 1985 1990 1995 2000 2005

Nominal interest rate

Chapter 26

Saving, Investment

and the Financial System

20092007200520032001199919971995199319911989

30

20

10

0

-10

-20

80

60

40

20

0

(% Ch. of 4-Qtr. Mov. Avg.) ($/Barrel)Investment Rebound Led by the Technology

Total Producer Durable Equipment Info Processing Equip.Oil Price (Right)

Tax Cuts have Eased the Oil Price Shock This Time

Average Effective Income Tax RatesFederal, State and Local Combined

20%

22%

24%

26%

28%

19

73

19

74

19

75

19

76

19

77

19

78

19

79

19

80

19

81

19

98

19

99

20

00

20

01

20

02

20

03

20

04

Past Oil Price Shock came when tax rates were rising rapidly

Bush Tax cuts have absorbed energy price shocks

Source: Prof. Larry J. Kimbell, Nov. 2004

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

Percentof GDP

1790 1810 1830 1850 1870 1890 1910 1930 1950 1970 1990

RevolutionaryWar

2010

CivilWar World War I

World War II

0

20

40

60

80

100

120

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