MACROECONOMIC MEASURES WHAT THEY ARE & HOW TO USE THEM Chapter 21, 22, 26

The Age of Macro Link

Outline GDP Comparing GDP across Time Inflation Real Interest Rates Balance of Payments

Gross Domestic Product

Quantity Aggregates To understand the macroeconomy, we need to measure it. Chief measure of economy is the level of production: GDP We need to combine the many goods produced or consumed in an economy into one measure =?

Gross Domestic Product (GDP) GDP is the sum of the value of new, final goods produced within the domestic borders of an economy. All goods sold in an economy share a common unit of measure: the price at which they are sold. Final goods are goods sold to their end-users Sum up the value of goods

Accounts are created by national statistical agencies UN System of National Accounts is the “internationally agreed standard set of recommendations” used by most countries. Annual data for many countries available at the UN Link

Three Methods for Calculating GDP 1. Expenditure Method - The sum of the domestic spending on final goods (less domestic demand satisfied by imports). 2. Production Method - The value added created in all the sectors of the economy. 3. Income Method – The Wage, Rent, Interest and Profit Income generated by the domestic economy.

Income=Expenditure=Value Added Value of final good expenditure is equal to value added at each stage of production. (Expenditure = Value Added) Value Added would be paid to workers, creditors, or kept as profits. (Income = Value Added)

Expenditure Approach Purchase of Final goods by end users are divided into two categories: 1. Consumption: A. Personal Consumption Expenditure (durables, nondurables & services); B. Government Consumption Expenditure (nondurables & services); 2. Investment: A. Gross Domestic Fixed Capital Formation (structures & equipment both public & private) B. Change in Inventories GDP = Consumption + Investment + Exports – Imports

Some Asian Expenditure Shares: 2010 Source: United Nations Main Aggregates DatabaseUnited Nations Main Aggregates DatabaseSource: United Nations Main Aggregates DatabaseUnited Nations Main Aggregates Database People’s Republic of China

Reconciliation GDP = Consumption + Investment + Exports – Imports Exports – Imports = Net Exports <> 0 Hong Kong Census and Statistics

Production Method At the plant level, Value added = Sales + Change in inventories - materials, intermediate inputs and energy costs. GDP is the sum of VA across establishments. The value of a final good is equal to the value added at each stage of production.

HK: VA by Sector Source: United Nations Main Aggregates DatabaseUnited Nations Main Aggregates Database

Table 035

Income Approach to Measuring GDP Value Added distributed as income to Employees, Owner/Creditors, & Gov’t 1. Compensation of employees (Wages, Benefits) 2. Net operating surplus (Profits, Net Interest, Rental Income) 3. Taxes on Production 20

Comparing GDP levels across time

GDP measures the value of the goods produced by an economy by using the market price of each good to assign it a value. Problem: Prices of goods in terms of money are changing overtime making comparisons in overall value difficult. Bias: Money prices are growing over time as money supply grows. Solution: Choose a Base Year’s prices as a fixed yardstick of value for different goods.

Real GDP: Y t GDP aka Nominal GDP aka Current Dollar GDP is the weighted sum of the number of goods produced using their current prices as the weight. Real GDP aka Constant Dollar GDP aka GDP adjusted for inflation is the weighted sum of the number of goods produces using the Base Year prices as yardsticks.

Calculating Real GDP Divide GDP into k = 1….K categories. Survey dollar value of goods produced at time t for each of k categories Survey average prices of goods of type k relative to a base year. Divide value of each good by the relative price

Solved Problem Real GDP: 2010 (2009 Base Year) PqPq Kitkat M&Ms Nominal GDP Real GDP

Real GDP vs. Nominal GDP Source: United Nations Main Aggregates DatabaseUnited Nations Main Aggregates Database

Inflation

Price Indices: P t Two most commonly used price indices are GDP Deflator and Consumer Price Index (CPI) The GDP deflator is the ratio of nominal GDP to Real GDP (multiplied by 100).

Consumer Price Index The CPI is the price of a representative market basket of goods relative to the price of that same basket during a benchmark/base year (multiplied by 100).

Hong Kong’s History of Prices

Q: What is Inflation? A: The Growth Rate of Price Level What is the CPI inflation rate in Candyland in 2010 using 2009 as the base year?

Inflation: prices are growing Disinflation: inflation is slowing down but still positive Deflation: inflation is negative and prices are actually dropping. Inflation Disinflation Deflation

Adjusting for Inflation We can use price indices to “adjust for inflation” - converting values measured in money into values measured in terms purchasing power of some reference year, r. Measured in $, observed at time t: N t Price level at time t: P t Price level in reference year: P r Measure adjusted for inflation –

Housing Price: Hong Kong Island Compare the price of housing in HK average price of an apartment on HK Island with an area between 100m 2 and 160m 2 in June 2012 : HK$273,767 /m 2 in June 1982: HK$15,078/m 2 How much did an apartment cost back then when expressed in today’s dollars?

Housing Price: Hong Kong Island The Hong Kong CPI (2010=100) was 32.3 in June 1982 and in June Calculate: In purchasing power terms, luxury housing in 2012 is more than 5 times as expensive as in 1982! LinkHong Kong Department of Census and StatisticsHong Kong Department of Census and Statistics.

ADJUSTING INTEREST RATES FOR INFLATION

Interest Rates Hong Kong HKMAHKMA HIBOR Exchange Fund Bill & Note Yields Best Lending Rate Government Bond Rates USD FREDFRED LIBOR T-Bills Prime Treasury Constant Maturity Corporate Bonds

Adjusting Interest Rates for Inflation Nominal rate represents how much money you will receive after 1 year for giving up 1 dollar of money today Real rate represents how many goods you can buy if you give up the opportunity to buy 1 good today. Nominal interest rate is money interest rate. Real interest rate is goods interest rate.

The real interest rate on the loan is defined as the future goods received relative to current goods foregone Real Interest Rate

Looking Backward HKMAHKMA, Hong Kong Department of Census and Statistics.Hong Kong Department of Census and Statistics

Looking Forward Borrowing and lending decisions must be based on forecast of future inflation: Ex Ante Real Rate Forecasts Ibond Yields Consensus Forecasts Central Bank Forecasts

BALANCE OF PAYMENTS

National Income vs. Domestic Income Net Factor Income [NFI] is income earned on overseas work or investments minus income generated domestically but paid to foreigners. GNIGDI Gross National IncomeGross Domestic Income = income earned by national residents = income created within domestic borders. GNI = GDI +NFI

Source: United Nations Main Aggregates DatabaseUnited Nations Main Aggregates Database

Compare Macau and the Philippines GDP or GNP Macau produces a lot of profits paid to overseas owners of casinos. Philippines workers earn a lot of income overseas. Which is larger Philippines’ GDP or Philippines GNP? Does Macau have greater GDP or GNP?

NFI Across Countries Source: United Nations Main Aggregates DatabaseUnited Nations Main Aggregates Database

Current Account Balance Current Account: NX +NFI NFI = Primary Income (Overseas Wage & Investment Income) + Secondary Income (Transfers) Census and Statistics Department

Global Imbalances Link World Current Account equals zero!

International Capital Flows Capital Outflows: domestic acquisition of foreign assets. Capital Inflows: foreign acquisition of domestic assets Net Capital Outflows = Capital Outflows – Capital Inflows Money is an asset. Most international financial transaction are swaps of one asset for another and have zero net effect on capital flows. Only net trade of foreign assets for goods or services creates opportunity for net capital flows. Current Account = Net Capital Outflows

Savings & Current Account Gross National Savings: GNS GNS = GNI – Consumption (PCE + GCE) GNI = GDP + NFI GDP = Consumption + Gross Capital Formation + Net Exports (Exports – Imports) GNS – GCF = NX + NFI = Current Account

Capital & Financial Account Current Account is gross capital outflows (i.e. national savings less national investment). Capital & Financial Account measures the allocation of gross inflows. Capital Account: Transfer of Real Assets Financial Account: Transfer of Financial Assets Reserve Assets: Central Bank Holdings of Liquid Foreign Assets Non-reserve Assets Direct Investment: (Taking Controlling Stakes in Foreign Entities) Portfolio Investment: (Stocks, Bonds) Financial Derivatives (Futures, Swaps) Other (Mostly Bank Loans and Deposits)

Capital & Financial Account 2011 Increases in financial assets, and decreases in liabilities should be shown as debits. Decreases in financial assets, and increases in liabilities should be shown as credits. Salient Feature of Balance of Payments

Learning Outcomes Students should be able to: Explain the different methods of calculating GDP Calculate simple real aggregates like real GDP. Use price indices to calculate inflation rates. Adjust nominal series for inflation. Define and calculate real ex post and ex ante real interest rates. Define the elements of the Balance of Payments Tables