Macroeconomics Mini-course Professor Pierre Yared

2 Questions What is GDP? What drives economic growth? What drives investment? What drives inflation and exchange rates? 2

3 Questions What is GDP? 3

4 Share of world production, 2002, using current exchange rates World GDP

5 GDP Definition Gross Domestic Product (GDP) The market value of final goods and services newly produced within a fixed period of time, within the geographic boundaries of a country

6 Three Equivalent Ways of Measuring GDP Production Approach Inputs (capital and labor) generate output Value added by individual firms Sectoral data (e.g., agriculture, manufacturing, services) Income Approach Payments made to inputs into production Wages to workers and rental rate to owners of capital Expenditure Approach Components: Consumption, investment, public spending, net exports Most important and common way of measuring GDP

7 GDP by Expenditure: International Comparisons, 2007 US China Brazil Sweden

8 Questions What drives economic growth? 8

9 US Growth Experience

10 How Do We Make Sense of Different Growth Experiences?

11 Production Over Many Years Even More Capital New Labor Production Consumption + Public Spending + Net Exports Investment Capital Labor New Production

12 Three Ways of Increasing GDP per Capita Capital per worker More machines per worker raises output per person Increases if investment is rising faster than the size of the work force Participation rate A higher fraction of population in workforce raises output per person Major increases have occurred through women’s liberation Total factor productivity (TFP) Corresponds to production process (black box) in flow diagram Implication: Same inputs can produce different outputs Most important determinant of cross-country income differences

13 Latin America Has Not Caught Up: Why? Y/Pop =N/Pop  A  (K/N) Latin America3, US11, Latin America / US (.27).3 = Latin America7, US33, Latin America / US (.32).3 =.71 Based on data and analysis in Cole, Ohanian, Riascos, Schmitz (2005)

14 What is Behind Total Factor Productivity? Education Important for workers to have skills and abilities to be productive Important to accumulate these over time through schooling Geography Important to develop effective agriculture to start growth Important to have low disease and a healthy workforce Important to have access to trade to adopt technology Institutions Important to prevent expropriation of investment by government Important to enforce legal contracts among parties Important to have low policy volatility and stable business environment

15 Questions What drives investment? 15

16 Investment is Financed by Savings Private Savings + Public Savings + International Savings = Investment 16

17 Three Sources of Savings 17 Private Savings Households can set aside resources or borrow them Businesses can also borrow or lend Public Savings Governments can set aside resources or borrow them Government deficit is negative of public savings i.e., Public spending minus revenues Private Savings + Public Savings = National Savings International Savings Neighbors can set aside resources or borrow them Current account deficit is international savings

18 Saving Identity in the US (% of GDP) Investment Private Savings Government Savings International Savings

19 Questions What drives inflation and exchange rates? 19

20 US Inflation

21 China Inflation

22 Argentina Hyperinflation

23 Determinants of Inflation Inflation is measured as the rate of change of the price level Various measures: CPI, GDP deflator, CPE Headline inflation: aggregates all prices Core inflation: Excludes food and energy and is less volatile What determines long run inflation? Money growth Also applies to hyperinflation at shorter frequencies Why do governments allow hyperinflation?: Seignorage Inflation is a form of indirect taxation on holders of money

24 Determinants of Exchange Rates Long run: Inflation differences affect exchange rate Currency experiencing more inflation is also depreciating Implication: Can fight hyperinflation by fixing exchange rate Medium run: International trade competition affect exchange rates Tendency for real price of goods to equalize through competition Cheaper goods from one country cause its currency to appreciate If central bank fixes exchange rate, nominal price of goods will rise Short run: Interest rate movements affect exchange rates Increase in interest rate in one country causes its currency to rise

25 Summary of Questions Answered What is GDP? What drives economic growth? What drives investment? What drives inflation and exchange rates? 25