1. FIN 30220: Macroeconomic Analysis Using Economic Data

2. “There are three kinds of lies; Lies, Damn Lies, and Statistics” - Mark Twain

3. Principle #1: What are you trying to measure? How is your statistic defined ? Is your statistic consistent with what you are trying to measure? Example: Poverty in the US

4. Source: CIA Factbook Lets see how we compare to other parts of the world… But, How would you define poverty?

5. Poverty was defined by Mollie Orshansky of the SSA in 1964 as 3 times the cost of the Dept. of Agriculture’s “Low cost food plan” That number has been indexed by inflation every year (The Johnson Administration later substituted the “economy” food plan) Family SizeThreshold One$11,670 Two$15,730 Three$19,790 Four$23,850 Five$27,910 Six$31,970 Seven$36,030 Eight$40,090 Nine$44,150 2014 POVERTY GUIDELINES

6. USDA Food Plans: 1964 (Poverty Line in 1964) (Approximate Poverty Line Today)

7. Food Budget as a percentage of household income: 1964 Lower Income Households spent around 33% on Food in 1964

9. Food Budget as a percentage of household income: 2003 In Fact, No Family Spends Anything Near 33% on Food Today!!! 16.5%

10. Suppose we use current food prices and the current budget share (Poverty Line in 2014?) Assuming Food is 16.5% of ones budget

11. Actual Calculation Redefined Household Budget (Current food prices) So, which is it and why should we care? 15% Difference

12. A more important question: Is it “absolute” income that we really care about? The Simpsons have a household income of $35,000. Median income is Springfield is $50,000 The Griffins have a household income of $45,000. Median income is Quahog is $85,000 Which of these two families do you think is happier?

13. Relative poverty measures define poverty as a certain percentage of median household income Poverty Line for 3.5 Person Household= $20,000 (40% of Median) Median Household Income = $50,000

14. Country Absolute poverty rate (threshold set at 40% of U.S. median household income) Relative poverty rate (40% of Median Income) Pre- transfer Post-transferPre-transferPost-transfer Sweden23.75.814.84.8 Norway9.21.712.44.0 Netherlands22.17.318.511.5 Finland11.93.712.43.1 Denmark26.45.917.44.8 Germany15.24.39.75.1 Switzerland12.53.810.99.1 Canada22.56.517.111.9 France36.19.821.86.1 Belgium26.86.019.54.1 Australia23.311.916.29.2 United Kingdom 16.88.716.48.2 United States21.011.721.011.7 Italy30.714.319.79.1 Altering the definition of poverty can make a big difference when comparing across countries!! It also makes a big difference when looking across time periods!

15. The common international poverty line has in the past been roughly $1 a day. In 2008, the World Bank came out with a revised figure of $1.25. Percentage of Population Living on Less that $1.25/day *Source: United Nations

16. 1991 Recession 2001 Recession Principle #2: How is your variable measured? Example: U.S. Unemployment 2007 Recession

17. Each month, the Department of Labor surveys 60,000 households. Each household is asked a series of questions: 1) “Are you currently working?” (Note: no mention of part time or full time) YES You are employed (147 Million) No 2) “Have you looked for a job in the past 30 days?” YES You are unemployed (9 Million) No You are not in the labor force (93 Million) Unemployment Rate (UR) = Unemployed Labor Force = 9 147+ 9 =.057 (5.7%)

18. Over the same month, the Department of Labor surveys 400,000 businesses and asks one question. 1) “How many employees are currently on your payroll?” Total Non-Farm Payrolls (140 Million) 1) “Are you currently working?” (Note: no mention of part time or full time) YES You are employed (147 Million) Wait a minute, that’s not what the household survey reported??? Which is it ???

19. The two surveys track each other reasonably well, but there are noticeable differences.

20. However, the establishment survey is subject to fairly large revisions

21. Pay Period Job at Company A count = 1 payroll jobcount = 2 payroll jobs Job at Company B The Establishment Survey Will often times “Double Count” Jobs Suppose you quit your job at company A and find a new job at company B – if this is done in the same payroll period (most payrolls are bi-weekly) you will be counted twice!! In months with high job turnover, the establishment survey will overstate employment. No TurnoverTurnover

22. 7.71M jobs arelost per quarter 8.11M jobs are gained per quarter Average US Labor Market Turnover FYI: Worst- case estimates predict outsourcing costs us 55,000 jobs per quarter.

23. Household Survey vs. Establishment Survey The household survey includes agricultural workers, self employed workers and private household workers. The establishment survey does not. The household survey counts people on unpaid leave as employed – the establishment survey does not. The household survey only counts people over the age of 16 – the establishment survey is not limited by age.

24. Main problems with measuring the unemployment rate  The unemployment rate doesn’t count underemployment (those that would like to work full time, but only work part time)  The “discouraged worker effect”: Those that have given up trying to find a job are counted as not in the labor force rather than unemployed  Selection bias: those that are unemployed are more likely to answer the survey.  Moral hazard: due to unemployment insurance, it is difficult to tell how hard individuals are trying to find work

25. Example: The Top 10 All Time Grossing Films (in Millions – US) 1)Avatar (2009): $760 2)Titanic(1997): $658 3)Marvel’s the Avengers (2012): $588 4)The Dark Knight (2008): $533 5)Star Wars I: The Phantom Menace (1999) $474 6)Star Wars IV: A New Hope (1977): $460 7)The Dark Knight Rises (2012) $449 8)Shrek 2 (2011): $441 9)E.T. The Extra-Terrestrial (1982): $435 10)The Hunger Games: Catching Fire (2013): $424 Principle #3: Is your variable in terms of current prices or fixed prices (Real vs. Nominal)

26. Real vs. Nominal Variables Nominal Variables are in terms of a current dollars. For example, you’re starting salary after college might be $50,000 per year. Real variables are in terms of some fixed commodity. Real variables measure purchasing power. If a gallon of gas costs $2.00, then we can calculate your “real” income. Real Income = Nominal Income Price = $50,000 $2.00 = 25,000

27. In 2009, a gallon of gas cost $3.50 Real Gross = Nominal Gross Price = $749M $3.50 = 214M Real Income = Nominal Gross Price = $460M $.62 = 742M In 1977, a gallon of gas cost $.62 (Gallons of Gas)

28. Usually, the “commodity” used for real variables is a particular year’s dollars. Suppose we want both grosses to reflect 1997 gas prices. (Gas was $1.26 in 1997) Real X = Target year Price Current Year Price Nominal X Real Gross = $270M $1.26 $3.50 $749M= Real Gross = $935M $1.26 $.62 $460M= ( 1997 Dollars) Current Year Target Year These two dollar figures are comparable because they represent the same year’s dollars!

29. The Top 10 All Time Grossing Films– Inflation Adjusted (Millions of 2000 Dollars) 1)Gone With the Wind (1939): $1,689 2)Star Wars Episode IV(1977): $960 3)The Sound of Music(1965): $768 4)ET: The Extraterrestrial(1982): $764 5)The Ten Commandments (1956): $706 6)Titanic (1997): $691 7)Jaws (1975): $690 8)Dr. Zhivago (1965): $669 9)The Exorcist (1973): $596 10)Snow White (1937): $587 Notes: Avatar falls to #14 ($516), a movie ticket in 1939 was $0.23

30. Suppose that you buy a $1,000, 90 Day Treasury Bill for $994 90 Days from now, you receive $1,000 from the government $1,000 - $994 $994 X 100 =.6% Alternatively, you could buy a $1,000, 5 year bond for $902 5 years from now, you receive $1,000 from the government $1,000 - $902 $902 X 100 =10.86% Which of these two assets is paying a higher return? Principle #4: Annualizing Example: Treasury Yields

31. $1$1.006$1.012$1.018$1.024 $1(1.006) Suppose that you could earn.6% interest every quarter (90 days). How much would you have in a year? 234 You earned 2.4% (Annualized) $1$?? $1(1+i) For the 5 year bond, we do the same process in reverse (how much would you have to earn per year to get a 10.86% return after 5 years)? 234 $1.1086 $1(1+i) 5 You earned 2.0% (Annualized)

32. GDP Time Principle #5: Economic data can be can be broken into 3 components:  Trend (many years)  Business Cycle (1-5 years)  Seasonal (Months) Trend Seasonal Cycle Business Cycle Recessions are periods of below trend growth Expansions are periods of above trend growth

33. Example: Tax Cuts, Tax Revenues and “VooDoo Economics” BracketOld RateNew Rate $0 - $6,00015%10% $6,000 - $27,25015% $27,251 - $67,55028%25% $67,551 - $141,60031%28% $141,601 - $307,30036%33% $307,301 +39.6%35% The Bush Tax Cuts of 2001 & 2003 lowered marginal tax rates across the board, lowered the capital gains tax, eliminated the estate tax, and lowered the “marriage penalty The tax cut was advertised as “the largest tax cut in history”

34. Suppose that the Griffin family has a household income of $50,000. Currently, the income tax rate is 20% of all income earned Under the current tax code, the Griffins pay $10,000 per year in Taxes. If the government cuts the tax rate to 10%, then the Griffin’s tax bill falls to $5,000 The cost of the tax cut is the $5,000 in lost revenues What do we mean by the “cost” of a tax cut, anyways? By this measure, the Bush Tax cuts have a price tag of around $130 Billion per year!!

35. Source: Congressional Budget Office Let’s take a look at previous marginal tax rate changes to put the Bush tax cut in a historical context. Wilson 1917 Coolidge 1925 FDR 1933 Kennedy 1964 Reagan 1981 Bush 2001/2003

36. Tax BillCost in Dollars (Billions) Kennedy Tax Cut (1964)$11.5 Reagan Tax Cut (1981)$38.3 Bush Tax Cut (2001)$73.8 Bush Tax Cut (2003)$60.8 Given an income distribution in 1964, 1981, and 2001/2003, we can estimate the per year “cost” of the three major tax cuts What’s the problem with comparing these numbers?

37. Kennedy 1964 Reagan 1981 Bush 2001/2003 Cost (in 1964 dollars): $11.5B CPI: 30.9 Real GDP: $2998.6B Cost (in 1981 dollars): $38.3B CPI: 87.0 Real GDP: $5,291.7B Cost (in 2003 dollars): $134.6B CPI: 175.1 Real GDP: $10,301B 175.1 30.9 $11.5B 175.1 87.0 $38.3B 175.1 $134.6B = $67.6B = $79.9B =$134.65B (2.25% of GDP) (1.5% of GDP) (1.3% of GDP) When expressed in real terms as a percentage of GDP, the Bush tax cuts aren’t so big after all!

38. Let’s return to the Griffin family. The Griffin family has a household income of $50,000. Currently, the income tax rate is 20%. Under the current tax code, the Johnsons pay $10,000 per year in Taxes. The drop in the tax rate caused revenues to increase rather than decrease! Suppose that a drop in the marginal rate encourages Lois Griffin to go back to work. With the two income earners, the Griffin family income rises to $120,000. At the 10% rate, their tax rises to $12,000 Could this happen?

39. Tax Rate Tax Revenues 0%100% Revenue Maximizing Rate Tax Revenues = (Tax Rate) (Tax Base) The basic logic behind the Laffer Curve is that the tax base should be negatively related to the tax rate. Is there evidence of a Laffer curve in practice?

40. Annual Federal Receipts (Billions) Year 0Year 1Year 2Year 3Year 4 Kennedy (1964)$116.8$130.8$148.8$153.0$186.9 Reagan (1981)$617.7$600.5$666.5$734.0$769.2 Bush (2001)$1,853.4$1,782.5$1,880.2$2,153.8$2,402.7 Tax Rate Tax Revenues 0%100% Revenue Maximizing Rate History suggests that taxes are two high, but be careful… Source: Congressional Budget Office

41. DateRevenues (Billions of Dollars) % ChangeCPIReal Revenues (Billions of 2003 Dollars) %Change 1964116.8---30.9720.8--- 1965130.811.331.2799.410.3 1966148.824.231.8892.321.3 196715327.032.9886.820.7 1968186.947.034.11045.237.2 1981617.7---87.01353.9--- 1982600.5-2.8294.31214.3-10.9 1983666.57.697.81299.6-4.10 198473417.25101.91373.61.4 1985769.221.9105.51390.42.6 20011853.4---175.12018.5--- 20021782.5-3.90177.11919.4-5.0 20031880.21.44181.71973.3-2.3 20042153.815.0185.22217.79.4 20052402.725.9190.72402.717.4 Once we account for price changes, the Laffer curve effect starts to disappear

42. After correcting for price changes, it appears that empirical evidence suggests the presence of a Laffer curve. However, we need to be careful.

43. *Source: Congressional Budget Office Kennedy 1964 Reagan 1981 Bush 2001/2003 Recession Expansion Each of these tax cuts was passed during a recession!

44. The Laffer effect of a tax cut should affect the trend, but not the cycle… GDP Time Old Tax Code New Tax Code This is what we have measured This is what we should be measuring In other words, we have overstated the Laffer effect in the previous slides