1. Measuring the US Economy Economic Indicators

2. Understanding the Lingo Annualized Rates Example: GDP Q3 (Final) = $11,814.9B (5.5%) Q2: GDP = $2,914.38 B X 4 = $11,657.5 B Q3: GDP = $2,953.73 B X 4 = $11,814.9 B ($11,814.9 - $11,657.5) X 100 = 1.35% X4 = 5.5% $11,657.5

3. Annualized Rates Annualized Rates Supposed that prices increased by.3% during the month of November. The annualized inflation rate is.3%X12 = The annualized inflation rate is.3%X12 = 3.6%

4. Understanding the Lingo Nominal (Current) Dollars vs. Real (Constant) Dollars Nominal (Current) Dollars vs. Real (Constant) Dollars Example: GDP(Q2) = $11,657.5 GDP(Q3) = $11,814.9T (5.5%) GDP(Q3) = $11,814.9T (5.5%) CPI(Q2) = 111.2 CPI(Q2) = 111.2 CPI(Q3) = 112.4 (4.3%) CPI(Q3) = 112.4 (4.3%) Real GDP(Q2) = (11,657.5/111.2)*100 = $10,483.36 Real GDP(Q3) = (11,814.9/112.4)*100 = $10,511.47 ($10,511.47 - $10,483.36) X100 X 4 = 1.07% $10,483.36 $10,483.36

5. Understanding the Lingo Seasonally Adjusted Seasonally Adjusted

6. Understanding the Lingo The X12 method estimates changes that occur in the same month each year and are generally of the same magnitude/direction. This seasonal component is then subtracted out. The X12 method estimates changes that occur in the same month each year and are generally of the same magnitude/direction. This seasonal component is then subtracted out.

7. Understanding the Lingo Moving Averages Moving Averages Example: Consider the following monthly Inflation Statistics (Monthly % Changes) Inflation Statistics (Monthly % Changes) MayJuneJulyAug.Sept.Oct.Nov.Dec..6.3-.1.1.2.6.2.2

8. Understanding the Lingo Moving Averages Moving Averages A moving average takes out the volatility by averaging several observations. For example, a would average the current observation with the previous 2 observations. A moving average takes out the volatility by averaging several observations. For example, a MA(3) would average the current observation with the previous 2 observations. MAMayJuneJulyAug.Sept.Oct.Nov.Dec. 1.6.3-.1.1.2.6.2.2 2.45.10.15.4.4.2 3.27.10.07.3.33 4.3.17.2.275.3

9. Understanding the Lingo Revisions Revisions ALL ECONOMIC DATA IS CONSTANTLY BEING REVISED!!! Example: GDP is reported three times Q3(Advance): 3.7% Q3 (Preliminary): 3.9% Q3 (Final): 4.0%

10. Understanding the Lingo Consensus Forecasts Consensus Forecasts Most of the news services construct consensus surveys by polling economists for their predictions on key indicators GDPActualConsensus Advance3.7%4.3% Preliminary3.9%3.7% Final4.0%3.9%

11. Understanding the Lingo Benchmarking Benchmarking Some indicators are reported relative to some benchmark. Example: Consumer Confidence in December was 102.3 (1985 = 100) Example: The CPI in November was 191.0 (1982-1984 = 100)

12. Understanding the Lingo The Business Cycle The Business Cycle Since WWII, the US has experienced 10 Business cycles with the average recession lasting 10 months. The most recent cycle was 2001: Peak (March 2001) Peak (March 2001) Trough (November 2001) Trough (November 2001)

13. So Many Statistics….So Little Time! The government releases over 50 statistics per month/quarter!! They can be roughly divided into 5 categories The government releases over 50 statistics per month/quarter!! They can be roughly divided into 5 categories Consumer Sector Consumer Sector Business Sector Business Sector Public Sector Public Sector International International Prices Prices

14. Major Indicators Consumer Sector (70% of Economic Activity) Consumer Sector (70% of Economic Activity) Retail Sales (Census Bureau) Consumer Credit (Federal Reserve) Personal Income and Spending (BEA) Employment Report (BLS) New Claims For Unemployment Insurance (Dept of Labor) Consumer Confidence/Sentiment (Conference Board/U. of Michigan) Auto Sales (Dept. of Commerce)

15. Major Indicators Business Sector(17% of Economic Activity) Business Sector(17% of Economic Activity) Industrial Production (Federal Reserve) Industrial Production (Federal Reserve) Capacity Utilization (Federal Reserve) Capacity Utilization (Federal Reserve) ISM Index (Institute for Supply Management) Durable Goods Orders (Census Bureau) Factory Orders (Census Bureau) Factory Orders (Census Bureau) Housing Starts (Census Bureau) New/Existing Home Sales (Nat. Assoc. of Realtors/Census Bureau) MBA Mortgage Applications (Mortgage Bankers Assoc.) Business inventories (Census Bureau) Business inventories (Census Bureau)

16. Major Indicators Public Sector(19% of Economic Activity) Public Sector(19% of Economic Activity) Construction Spending (Census) Construction Spending (Census) Federal Budget Report (Treasury Dept) International Sector (-6% of Economic Activity) Net Exports (Bureau of Economic Analysis) Current Account (Bureau of Economic Analysis)

17. Major Indicators Prices Prices Consumer Price Index (BLS) Producer Price Index (BLS) Employment Cost Index (BLS) Non-Farm Productivity (BLS) Import/Export Prices (BLS)

18. Criteria For “Good” Indicators Accuracy: Accuracy: Most economic data is compiled through surveys – larger survey pools are more accurate. Most economic data is compiled through surveys – larger survey pools are more accurate. To measure consumer confidence, the conference board polls 5,000 households per month. To measure consumer confidence, the conference board polls 5,000 households per month. To measure prices, the bureau of labor statistics polls 28,000 retail outlets per month! (on 80,000 products) To measure prices, the bureau of labor statistics polls 28,000 retail outlets per month! (on 80,000 products) Some statistics are subject to large revisions. Some statistics are subject to large revisions. Housing starts are rarely revised while the monthly construction spending report often gets substantial revisions Housing starts are rarely revised while the monthly construction spending report often gets substantial revisions

19. Criteria For “Good” Indicators Timeliness Timeliness The BLS employment situation report comes out a week after the end of the month, while consumer credit is reported on a two month delay.

20. Predictive Ability Blue Arrow = Peak Blue Arrow = Peak Red Arrow = Trough Red Arrow = Trough

21. Predictive Ability Blue Arrow = Peak Blue Arrow = Peak Red Arrow = Trough Red Arrow = Trough

22. Predictive Ability Blue Arrow = Peak Blue Arrow = Peak Red Arrow = Trough Red Arrow = Trough

23. Criteria For “Good” Indicators Business Cycle Stage Business Cycle Stage During recessions, we’re looking for signs of recovery During recessions, we’re looking for signs of recovery Housing Starts Housing Starts Auto Sales Auto Sales Employment Employment During expansions we tend to be more concerned with inflation During expansions we tend to be more concerned with inflation CPI CPI Employment cost index Employment cost index

24. Criteria For “Good” Indicators Who Are You? Who Are You? Stock markets are most concerned with consumer/business spending which drive corporate profits (Employment, Retail Sales) Stock markets are most concerned with consumer/business spending which drive corporate profits (Employment, Retail Sales) Bond Markets worry about inflation (CPI, PPI) Bond Markets worry about inflation (CPI, PPI) Foreign Exchange Markets (Current Account, GDP, Productivity) Foreign Exchange Markets (Current Account, GDP, Productivity)

25. A Shortcut Index of Leading Indicators (Conference Board) Index of Leading Indicators (Conference Board) Average Hourly Workweek in Manufacturing (19.7%) Average Hourly Workweek in Manufacturing (19.7%) Weekly Unemployment Claims (2.5%) Weekly Unemployment Claims (2.5%) Manufacturers’ New Orders – Consumer Goods (5.9%) Manufacturers’ New Orders – Consumer Goods (5.9%) Manufacturers’ New Orders – Capital Goods (1.5%) Manufacturers’ New Orders – Capital Goods (1.5%) Vendor Performance (Delivery Time Index) (2.9%) Vendor Performance (Delivery Time Index) (2.9%) Building Permits for New Homes (2%) Building Permits for New Homes (2%) Index of Consumer Expectations (1.9%) Index of Consumer Expectations (1.9%) S&P Index (2.9%) S&P Index (2.9%) Real (inflation adjusted) M2 Money Supply (27.7%) Real (inflation adjusted) M2 Money Supply (27.7%) Interest Spread Between 10 Yr. Bonds & Fed Funds Rate (33%) Interest Spread Between 10 Yr. Bonds & Fed Funds Rate (33%)

26. Index of Leading Indicators Blue Arrow = Peak Blue Arrow = Peak Red Arrow = Trough Red Arrow = Trough

27. The Most Influential U.S. Economic Indicators

28. The Big One: Employment : Total (Non-Farm) Employment, Unemployment Rate, Average Duration, etc…..Are people working? What is it: Total (Non-Farm) Employment, Unemployment Rate, Average Duration, etc…..Are people working? : 8:00AM, the first Friday of the month following the coverage month Release Time: 8:00AM, the first Friday of the month following the coverage month : Monthly Frequency: Monthly : Bureau of Labor Statistics Source: Bureau of Labor Statistics : Frequent Revisions…sometimes major! Revisions: Frequent Revisions…sometimes major!

29. The Household Survey Each month, the BLS contacts 60,000 households (95% response rate) and places each in one of four categories : Each month, the BLS contacts 60,000 households (95% response rate) and places each in one of four categories : A. A.Under 16 or institutionalized (or military) B. B.Choose not to work: Not in Labor Force C. C.Choose to work and are working: Employed D. D.Choose to work, but can’t find a job: Unemployed Unemployment Rate = D/(D+C)

30. Household Survey US Population: 290M US Population: 290M Civilian Population: 220M Civilian Population: 220M Labor Force: 147M Labor Force: 147M Employment: 139M Employment: 139M Unemployment: 8M Unemployment: 8M Participation Rate (147M/220M)*100 = 66% Employment Ratio (138M/220M)*100 = 62% Unemployment Rate (8M/147M)*100 = 5.4% UR = 1 – (ER/PR)

31. US Participation Rate

33. Establishment (Payroll) Survey Each month, the BLS contacts 400,000 firms!! (60% - 70%) response rate. Each firm is asked to report total employment. Each month, the BLS contacts 400,000 firms!! (60% - 70%) response rate. Each firm is asked to report total employment. Employment: 131M?? Employment: 131M??

34. ???

35. The US Labor Market Labor markets are difficult to characterize because they are always in motion….. Labor markets are difficult to characterize because they are always in motion….. NOT IN LABOR FORCE EMPLOYED UNEMPLOYED Average Turnover is around 2.5 Million people per Month!!

36. Duration Most unemployment spells in the US are short. Most unemployment spells in the US are short. <5 Wks: 2.9m <5 Wks: 2.9m 5-15 Wks: 2.2m 5-15 Wks: 2.2m + >15 Wks: 2.9m Total: 8.0m Total: 8.0m Average duration in the US is approx. 19wks Average duration in the US is approx. 19wks Median: 9wks Median: 9wks Average Duration In 1 year, how many people are unemployed for 5 wks? In 1 year, how many people are unemployed for 5 wks? (52/5)*2.9M = 30.1M How many people are unemployed for 10 wks? How many people are unemployed for 10 wks? (52/10)*2.2M = 11.4M For 20 wks? For 20 wks? +(52/20)*2.9M = 7.5M Total 49M Total 49M AD = (30.1/49)*(5wks) + (11.4/49)*(10wks) + (7.5/49)*(20wks) = AD = (30.1/49)*(5wks) + (11.4/49)*(10wks) + (7.5/49)*(20wks) = 8.5wks

37. Unemployment Duration

39. What’s “Normal” in the Labor Market? Frictional Unemployment: Currently unemployed, but in the process of getting a job (i.e., short term unemployment): 3.5% + Structural Unemployment (chronic unemployment): 1.5% “Natural Rate of Unemployment”: “Natural Rate of Unemployment”: 5% Given the current unemployment rate of 5.4%, we currently have a of.4% Given the current unemployment rate of 5.4%, we currently have a cyclical unemployment rate of.4%

40. US Unemployment Rate: 1990-2002

41. Is the “Natural Rate” Growing?

42. The cost of unemployment “Capacity Output” of an economy is the level of output associated with full employment (i.e., unemployment is at the natural rate) “Capacity Output” of an economy is the level of output associated with full employment (i.e., unemployment is at the natural rate) The “output gap” is the difference between capacity output and actual output The “output gap” is the difference between capacity output and actual output Okun’s law states that every 1% increase in cyclical unemployment increases the output gap by 2.5%. Okun’s law states that every 1% increase in cyclical unemployment increases the output gap by 2.5%. Therefore, our current.4% cyclical unemployment rate implies an output gap of 1% GPD ( Roughly $110B! ) Therefore, our current.4% cyclical unemployment rate implies an output gap of 1% GPD ( Roughly $110B! )

43. GDP (Gross Domestic Product) : Current dollar value of all goods and service produced in the US What is it: Current dollar value of all goods and service produced in the US : 8:30AM, The final week of the month following the covered quarter (each quarter has three estimates: Advance, Preliminary, Final) Release Time: 8:30AM, The final week of the month following the covered quarter (each quarter has three estimates: Advance, Preliminary, Final) : Quarterly Frequency: Quarterly : Bureau of Economic Analysis Source: Bureau of Economic Analysis : They usually get it right by the final revision. Revisions: They usually get it right by the final revision.

44. Calculating GDP If our economy was horizontally oriented (i.e. everyone produces final goods) economy, calculating GDP would be easy: If our economy was horizontally oriented (i.e. everyone produces final goods) economy, calculating GDP would be easy: GDP = Price*Quantity (Added up over all goods) Our economy is vertically oriented (some manufacturers produce Therefore, we must avoid double counting. Our economy is vertically oriented (some manufacturers produce intermediate goods). Therefore, we must avoid double counting. Each manufacturer reports output on a Each manufacturer reports output on a value added basis

45. National Income and Product Accounts GDP (2003) Consumer Goods: $7,752.2B Goods: $7,752.2BInvestment Goods: $1,667.5B Goods: $1,667.5BGovernment Expenditures: $2,055.7B Net Exports: -$491.5B $10,983.9 Income (2003) GDP: $10,983.9 - Net Factor Payments: $37.9 GNP: $10,946.0 - Depreciation $1,370.1 NNP: $9,575.9 - Indirect Taxes: $834.4 National Income: National Income: $8741.5

46. National Income and Product Accounts Income (2003) GDP: $10,983.9 - Net Factor Payments: $37.9 GNP: $10,946.0 - Depreciation $1,370.1 NNP: $9,575.9 - Indirect Taxes: $834.4 National Income: National Income: $8741.5 Income (2003) Wages: $6,039.5 Proprietor’s Income: $774.6 Rental Income: $127.9 Corporate Profits: $1,294.2 Interest: $546.9 National Income: National Income: $8,783.1 Statistical Discrepancy: Statistical Discrepancy: 41.6B

47. Real vs. Nominal Recall that GDP will grow either because we are producing more, or because prices are increasing. To correct for this, the BEA, repeats the previous calculations using a set of “Base year” prices. Recall that GDP will grow either because we are producing more, or because prices are increasing. To correct for this, the BEA, repeats the previous calculations using a set of “Base year” prices. GDP (2003 Prices) = $10,983.9 GDP (2000 Prices) = $10,397.2 Note that this implicitly implies a Price index……The GDP Deflator! P(2000) = 1 P(2003) = $10,983.9/$10,397.2 = 1.056 (i.e. prices increased by 5.6% from 2000 – 2003)

48. GDP Facts GDP in 2004 is $11,649.3 Billion while GDP in 1950 was $275.7 Billion. (an increase of 4200%). GDP in 2004 is $11,649.3 Billion while GDP in 1950 was $275.7 Billion. (an increase of 4200%). Real GDP (2000 $s) in 2004 was $10,788.9 Billion while Real GDP in 1950 was $1,777.5 Billion (A 600% increase) Real GDP (2000 $s) in 2004 was $10,788.9 Billion while Real GDP in 1950 was $1,777.5 Billion (A 600% increase) Real GDP per capita in 2003 is $36,911 compared to $10,736 in 1950 ( a 350% increase). Real GDP per capita in 2003 is $36,911 compared to $10,736 in 1950 ( a 350% increase). Median real income in 2003 is approximately $24,000 while median real income in 1950 was approximately $8,000 (a 300% increase) Median real income in 2003 is approximately $24,000 while median real income in 1950 was approximately $8,000 (a 300% increase)

49. CPI (Consumer Price Index) : The “Average” Price of Consumer Goods in the US What is it: The “Average” Price of Consumer Goods in the US : 8:30AM, The second or third week following the covered month Release Time: 8:30AM, The second or third week following the covered month : Monthly Frequency: Monthly : Bureau of Labor Statistics Source: Bureau of Labor Statistics : No Revisions except for an annual correction done in February. Revisions: No Revisions except for an annual correction done in February.

50. Fixed Weight Indices A price index is meant to capture the average price of goods and services in the economy. Therefore, any price index should be a weighted average of all (or at least, most) prices in the economy. A price index is meant to capture the average price of goods and services in the economy. Therefore, any price index should be a weighted average of all (or at least, most) prices in the economy. With any fixed weight index, the weights used in the index are chosen ex ante and remain fixed over time (hence, the name fixed weight index). With any fixed weight index, the weights used in the index are chosen ex ante and remain fixed over time (hence, the name fixed weight index). Think of the a fixed weight index as simply defining a “basket” of goods. The value of that index is the cost of that basket. Think of the a fixed weight index as simply defining a “basket” of goods. The value of that index is the cost of that basket.

51. Example: A Fixed Weight Index Suppose that in 2002, Apples cost $3 and Oranges cost $5. In 2003, Apples cost $4 (a 30% increase) and oranges cost $6. (20% increase) Suppose that in 2002, Apples cost $3 and Oranges cost $5. In 2003, Apples cost $4 (a 30% increase) and oranges cost $6. (20% increase) Let’s define the price index as Let’s define the price index as.5( Apples) +.5(Oranges) Usually, prices are in represented in terms of a “base year”. This is done by dividing every year by the base year price Usually, prices are in represented in terms of a “base year”. This is done by dividing every year by the base year price P(2002) =.5($3) +.5($5) = $4. = $4. P(2003) =.5($4) +.5($6) = $5 = $5 P(2002) = 1 (or 100) P(2003) = $5/$4 = 1.25 (or 125)

52. The Consumer Price Index

53. The inflation rate is just the percentage change in the CPI. The inflation rate is just the percentage change in the CPI. The “core inflation rate” is the the percentage change in the CPI less energy and food prices (known to be extremely volatile) The “core inflation rate” is the the percentage change in the CPI less energy and food prices (known to be extremely volatile) The producer price index (PPI) is the corporate analogue to the CPI The producer price index (PPI) is the corporate analogue to the CPI

54. Problems with the CPI A formal commission headed by Stanford economist Michael Boskin in 1996 determined that the CPI overestimated by as much as 2.4% per year A formal commission headed by Stanford economist Michael Boskin in 1996 determined that the CPI overestimated by as much as 2.4% per year Formula Bias:.3-.4% Substitution Bias:.2-.4% Outlet Bias:.1-.3% New Products:.2-.7% Quality Bias:.2-.6% Total: 1 - 2.4%

55. Variable Weight Indices Variable weight indices correct for the substitution bias of the CPI by allowing the weights to vary over time. Variable weight indices correct for the substitution bias of the CPI by allowing the weights to vary over time. The GDP Deflator (or, more commonly, the deflator) uses actual production of each commodity as a fraction of total GDP for the weights. Therefore as production (and, hence, consumption) of a commodity rises, so does its weight in the deflator. The GDP Deflator (or, more commonly, the deflator) uses actual production of each commodity as a fraction of total GDP for the weights. Therefore as production (and, hence, consumption) of a commodity rises, so does its weight in the deflator.

56. Chain Weighting During periods of large relative price changes, the choice of base year is critical for determining real growth and the behavior of prices. During periods of large relative price changes, the choice of base year is critical for determining real growth and the behavior of prices. Chain weighting is a process by which a range of years is chosen for the “base year” and that range moves over time. Chain weighting is a process by which a range of years is chosen for the “base year” and that range moves over time.

57. Productivity : A Measure of Efficiency in the Production Sector What is it: A Measure of Efficiency in the Production Sector : 8:30AM, Around five weeks following the covered quarter Release Time: 8:30AM, Around five weeks following the covered quarter : Quarterly Frequency: Quarterly : Bureau of Labor Statistics Source: Bureau of Labor Statistics : Can be substantial….this depends on revisions to both GDP and Employment Revisions: Can be substantial….this depends on revisions to both GDP and Employment

58. Calculating Productivity Step #1: Take real GDP and subtract out government output and farm output $10,397.2 - $2,079.44 = $8,317.8 $10,397.2 - $2,079.44 = $8,317.8 Step #2: Divide by Total Labor Hours (in the Employment Situation Report) (Employment * Average Hours *52 = Total Hours) (Employment * Average Hours *52 = Total Hours) $8,317.8/244.3 = $34/hr. $8,317.8/244.3 = $34/hr. Step #3: Productivity is benchmarked relative to a “base year” Suppose that Output/hr in 1992 was equal to $28.hr, then Prod(1992) = 100 Prod(2003) = 100*(34/28) = 121.4

59. Y = real output N= labor hours K=capital input Y/N = Labor Productivity y – n = Labor Productivity growth (lower case letters = compound annual average rates of growth) Y = A K β N 1-β = Production function (Cobb Douglas) A = Y/(K β N 1-β ) = Multifactor Productivity a = y – βk – (1-β)n = Growth Rate of MFP y - n = a + β (k - n) = Growth rate of labor productivity Labor and Multifactor Productivity Growth Formulas

60. Labor Productivity, United States, 1919-2000 1919-19292.27 1929-19412.35 1941-19481.71 1948-19732.88 1973-19891.33 1989-20001.97 1973-19951.40 1995-20002.43 Sources: 1919-48: Kendrick (1961), Table A-23. 1948-2000: Bureau of Labor Statistics: www.bls.gov 1948-2000: Bureau of Labor Statistics: www.bls.gov

61. MFP United States, 1919-2000 1919-19292.02 1929-19412.31 1941-19481.29 1948-19731.90 1973-1989.34 1989-2000.78 1973-1995.38 1995-20001.14 Sources: 1919-48: Field (2003); Kendrick (1961) 1948-2000: Bureau of Labor Statistics: www.bls.gov 1948-2000: Bureau of Labor Statistics: www.bls.gov

62. Consumer Confidence : A Measure of how consumers feel about the economy What is it: A Measure of how consumers feel about the economy : 10:00AM, The last Tuesday of the month being surveyed Release Time: 10:00AM, The last Tuesday of the month being surveyed : Monthly Frequency: Monthly : The Conference Board Source: The Conference Board : Minor Revisions: Minor

63. Measuring Consumer Confidence The board surveys 5,000 households/month and asks the following questions: 1) How would you rate the present general business conditions in your area? Good, Normal, or Bad. 2) How about six months from now? Better, Same, Worse. 3) What would you say about available jobs in your area? Plenty, not so many, hard to get. 4) What about six months from now? Better, Same, Worse. 5) What would you guess your family income to be six months from now? Higher, same, lower.

64. Measuring Consumer Confidence The board surveys 5,000 households/month and asks the following questions: For each question, the “Neutral” Response is thrown out. Step #1: For each question, the “Neutral” Response is thrown out. The responses are transformed into a percentage Step #2: The responses are transformed into a percentage Relative Response = Positive/(Positive + Negative) Relative Response = Positive/(Positive + Negative) The Benchmark is relative to 1985. Step #3: The Benchmark is relative to 1985. Benchmarked Answer = Rel. Response (Current)/Relative Response(1985) : Average over the 5 questions Step #4: Average over the 5 questions

65. Example: Consumer Confidence QuestionPositiveNeutralNegativeRelativeBenchmarked #13,0001,0001,000.751.07 #22,0005002,500.441.10 #32,9001002,000.591.18 #41,5751,5751,850.460.76 #51,0001,0003,000.250.63 Average20958352070.50. 948*100 = 94.8 Relative Values for 1985 are:.70,.40,.50,.60,.40 (Average =.52) Relative Values for 1985 are:.70,.40,.50,.60,.40 (Average =.52)

66. The Bottom Line Each statistic has its strengths and weaknesses. Each statistic has its strengths and weaknesses. Rarely will all the indicators “agree” with one another. Rarely will all the indicators “agree” with one another. Each indicator must be looked at in the context of “the big picture”. Each indicator must be looked at in the context of “the big picture”.