Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Macroeconomics: Introduction

Alan G. Isaac

American University

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Macroeconomic InquiriesMacroeconomic Modeling

Preliminaries

These lecture slides indicate the talking points covered in class. Theyare not a substitute for the lectures.I will appreciate learning of any typos and/or errors.

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Macroeconomic InquiriesMacroeconomic Modeling

Macroeconomics vs. Microeconomics

macroeconomics economy-wide variables (aggregates)

microeconomics individual markets

microfoundations of macro underlying behavior of indviduals

macrofoundations of micro institutional and environmental setting

Alan G. Isaac Macroeconomics: Introduction

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Macroeconomic Inquiries

All macro textbooks address the causes of

growth

business cycles

inflation

We hope that understanding these can help us implement betterpolicies---policies that can improve human well-being by

promoting growth,

moderating business cycles,

constraining inflation.

Question:Do you think there are other major macroeconomic inquiries?

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

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Other Inquiries

Might involuntary unemployment deserve to be listed separatelyfrom business cycles?

Might we be interested in the causes of the distribution of incomeand wealth?

What role should environmental constraints play in macro policyplanning?

Question:What role does ideology play in determining which questions we findinteresting, or are even willing to discuss?

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Background of the Class

Question:What have you learned to view as determinants of inflation,unemployment, business cycles, growth, and the distribution of incomeand wealth?Question:Do you think government policy can influence inflation, unemployment,business cycles, growth, and the distribution of income and wealth?

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

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Course Approach

In this course, we try to answer such questions by collecting evidenceon the relationships between macroeconomic variables.

macroeconomic (aggregative) variables measurable aggregatequantities such as GDP or unemployment that weattempt to relate to macroeconomic concepts.

When then build a model in an attempt to explain our observations.

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

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Investigative Strategy

ask a macroeconomic question (“why are we richer today than acentury ago”)

document stylized facts relevant to the question

develop a simple model that incorporates certain stylized facts

check predictions of model against other stylized facts

use novel predictions of models to search for new facts

revise model

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

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Macroeconomic InquiriesMacroeconomic Modeling

The Structure of Economic Models

Types of VaraiblesEndogenousExogenousParameters (like exogs but less “variable”)

Types of EquationsIdentitiesBehavioralTechnologicalEquilibrium

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The Structure of Economic Models

Source: Jones (2011)

Alan G. Isaac Macroeconomics: Introduction

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The Use of Economic Models

Models can be used to explore counterfactual scenarios and to predictthe effects of policy changes.

Comparative statics: how do the final values of the endogenousvariables respond to the exogenous variables?

Comparative dynamics: how does the path of the endogenousvariables respond to the path of the exogenousvariables?

The predictions of economic models are usually qualitative.A truly successful model makes quantitative predictions as well. (Veryhard!)

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Three Views of Growth

Real GDP: http://research.stlouisfed.org/fred2/graph/?chart_type=line&width=800&height=480&preserve_ratio=true&id=GDPCA

Logarithm of Real GDP:http://research.stlouisfed.org/fred2/graph/?chart_type=line&width=800&height=480&preserve_ratio=true&id=GDPCA&transformation=log

Annual Percentage Change in Real GDP:\http://research.stlouisfed.org/fred2/graph/?chart_type=line&width=800&height=480&preserve_ratio=true&id=GDPCA&transformation=pc1

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Real GDP

Source: http://research.stlouisfed.org/fred2Alan G. Isaac Macroeconomics: Introduction

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Population Growth: Linear Scale vs. Ratio Scale

It is usually more informative to display series that grow exponentiallywith a ratio scale rather than a linear scale.

Figure: Population Growth: Linear Scale vs. Ratio Scale

Source: Jones (2011)Comment: Be careful about the origin for the ratio scale!

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Real GDP (Ratio Scale)

Source: http://research.stlouisfed.org/fred2Alan G. Isaac Macroeconomics: Introduction

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Real GDP (Ratio Scale)

Source: ERP 2011, Fig 3-1Alan G. Isaac Macroeconomics: Introduction

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Real GDP per capita (US): Linear Scale

Most real income growth has been extremely recent. (But watch out:this is a linear scale, not a ratio scale.)

Figure: Real GDP per capita (US): Linear Scale

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Trends and Deviations

When we look at the level of real GDP over time, out attention is drawnto an apparent long-run trend.From this perspective, short-run fluctuations are swamped by long-rungrowth.

potential output flexible trend

cost of recession 1982: 5% of potential output ($1500 per family)

Alan G. Isaac Macroeconomics: Introduction

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Real GDP per capita (US): Ratio Scale

Figure: Real GDP per capita (US): Ratio Scale

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GDP, GDP p.c., and Population (US)

Figure: GDP, GDP p.c., and Population (US)

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AR vs. US: Real GDP p.c. (Ratio Scale)

1850 1900 1950 2000103

104

ARUS

Data Source: http://www.ggdc.net/maddison/Units: 1990 Dollars (PPP)Alan G. Isaac Macroeconomics: Introduction

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Real GDP per capita (7 countries)

Figure: Real GDP per capita (7 countries)

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Real GDP p.c.: Levels (2000) and Growth Rates(1960--2000)

Figure: Real GDP p.c.: Levels (2000) and Growth Rates (1960--2000)

Note: Real GDP per capita is on a ratio scale, with US=1Source: Jones (2008), who used PWT data

Alan G. Isaac Macroeconomics: Introduction

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World Income Distribution

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

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Annual Percentage Change of Real GDP

Figure: Annual Percentage Change of Real GDP

Source: http://research.stlouisfed.org/fred2Alan G. Isaac Macroeconomics: Introduction

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Great Recession

Source: ERP 2011 Fig 2-1Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

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US Unemployment Rate

Source: http://research.stlouisfed.org/fred2/series/UNRATE?cid=12

Alan G. Isaac Macroeconomics: Introduction

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Unemployment Questions

What caused the Great Depression, with peak unemployment of25% in the US?

Until 1980, Europe had lower unemployment than the US! Whythe change?

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Unemployment Since 1960: US, Europe, and Japan

Figure: Unemployment Rates since 1960: US, Europe, and Japan

Source: Jones (2009)Alan G. Isaac Macroeconomics: Introduction

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Recent Unemployment Comparisons

Source: http://www.bls.gov/fls/intl_unemployment_rates_monthly.htm

Alan G. Isaac Macroeconomics: Introduction

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Recent Unemployment Comparisons

Source: http://www.bls.gov/fls/intl_unemployment_rates_monthly.htmAlan G. Isaac Macroeconomics: Introduction

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US Inflation

Source: http://research.stlouisfed.org/fred2/graph/?chart_type=line&id=CPIAUCNS&transformation=pc1

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Inflation Rates since 1960

Figure: Inflation Rates Since 1960: US, Europe, and Japan

Source: Jones (2011)Alan G. Isaac Macroeconomics: Introduction

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Inflation Questions

What are the causes of inflation?

How do monetary and fiscal policy contribute to inflation?

Why has rich-country inflation been falling since the early 1980s?

Why do some countries experience hyperinflation?

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US Income Shares (by Quintile)

Figure: Income Shares (by Quintile)

Data Source: Bureau of the CensusAlan G. Isaac Macroeconomics: Introduction

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Tax Rates

Source: ERP (2010, Figure 5.7)Alan G. Isaac Macroeconomics: Introduction

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Income Mobility

Figure: Income Shares (by Quintile)

Source: http://www.stlouisfed.org/publications/itv/articles/?id=1920

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Notable Crisis Events

2007

July: 2 Bear Stearns hedge funds collapse (subprime relatedlosses)

Sep: run on Northern Rock (British Bank)

Sep 18: first fed funds rate cut

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Notable Crisis Events ...

2008

Feb: nationalization of Northern Rock

Mar 16: Bear Stearns acquired by JP Morgan

Jul 11: Indymac fails

Sep 15: Lehman Brothers files for Banruptcy

Sep 16: Reserve Primary Fund “breaks the buck”; run on moneymarket funds

Sep 19: US Treasury offers insurance to money market funds

Sep: GSE conservatorship; Merril Lynch acquire, WashingtonMutual acquired

Jan 2007--Sep 2009: US and European Banks write down $1T; morethan 2/3 is loans. (IMF expects total losses will approach $2.5T.)

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Spread over 10-Year Treasury Yields

Figure: Spread over 10-Year Treasury Yields

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Interest Rate Questions

Why are interest rates important to the macroeconomy?

What determines interest rates?

How can monetary policy affect interest ratest?

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Housing Prices

Source: ERP 2010, Fig 1-1

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Stock Prices

Source: ERP 2010, Fig 2-6

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Some policy responses

2008-09-07: Fannie Mae and Freddie Mac placed in conservatorship

2008-09-16: Fed extends $85B line of credit to AIG

2008-09-19: Treasury announces temporary guarantee progrm formoney market mutual funds

2008-10-03: Congress passes and Bush signs Emergency EconomicStabilization Act of 2008 (EESA), including up to $700Bfor the Troubles Asset Relief Program (TARP). The initialTARP tranche of $350B used to purchase preferredequity shares in financial institutions.

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Some policy responses ...

2008-12 -- 2009-06 Bush extends $17.4B through Auto IndustryFinancing Program and another $7.5B to GMAC andChrysler Financial. Obama provides almost twice thatas GM and Chrysler go through bankruptcy (to promote“orderly restructuring”.

2009-02-17: Obama signs American Recovery and Reinvestment Actof 2009 (ARRA), containing $787B in tax cuts andspending increases, making it the largest US fiscalstimulus (about 2% of GDP in 2009 and 2.25% in 2010).

2009-06: Car Allowance Rebate System (CARS)

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Monetary Stimulus

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Discretionary Added Fiscal Stimulus

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US Fiscal and Current Account Deficits

Budget deficits and trade deficits may affect future living standards.

Figure: US Fiscal and Current Account DeficitsAlan G. Isaac Macroeconomics: Introduction

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US Exchange Rate

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Net International Investment Position

NIIP

not the same as wealth!

A rise in the value of our stock market raises our wealth butemph{reduces} our NIIP (because foreign residents hold USstock).

2009 US net equity postion: $3T

2009 US net debt postion: -$5T

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Composition of Assets and Liabilities (US v. RoW)

Figure: Composition of Assets and Liabilities (US v. RoW)

Source: Milesi (2009)Alan G. Isaac Macroeconomics: Introduction

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Reversal of Fortune

Capital gains are no longer offsetting our current account deficit.

Figure: Reversal of Fortune

Source: Milesi (2009)

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

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Section 1National Income Accounting

Background

One reads with dismay of Presidents Hoover and thenRoosevelt designing policies to combat the GreatDepression of the 1930s on the basis of such sketchy dataas stock price indices, freight car loadings, and incompleteindices of industrial production. The fact was thatcomprehensive measures of national income and output didnot exist at the time. The Depression, and with it the growingrole of government in the economy, emphasized the need forsuch measures and led to the development of acomprehensive set of national income accounts.[froyen-2005-macrotp], as quoted in[landefeld.seskin.fraumeni-2008-jep]

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Section 1National Income Accounting

Background ...

Prior to the Great Depression, we had no systematic evaluation ofaggregate output.The nation was in the midst of the Great Depression, but policymakershad no comprehensive picture of what was happening to the economy.In response, Simon Kuznets and his colleagues in the 1930s gave usour first official measurements [kuznets-1934-gpo].

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Section 1National Income Accounting

Stocks and Flows

Stock: measured at a point in time, does not need to refer to a periodof timeFlow: measured over a period of timeExamples: wealth vs. saving, debt vs. deficits

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Section 1National Income Accounting

Measuring Aggregate Production

GDP: market value of all final goods and services produced bydomestic residents in a given year.

We can look directly at expenditures on final goods and services(expenditure approach), or we can equivalently look at payments tothe factors of production (income approach).

Households are the owners of the factors of production.

Firms produce goods and use their revenues to pay for thefactors of production.

For simplicity, we aggregate the payments to factors into twocategories: labor income (“wages”) and rent (“profits”).

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Section 1National Income Accounting

Components of GDP

Basic NIPA identity: Y = C + I +G+(IM −EX)

0

20

40

60

80

100

Percentof

GDP

(2009)

C I G NX

71

11

21

-3

Data Source:http://www.bea.gov/national/txt/dpga.txt Table1.1.5

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Section 1National Income Accounting

US Consumption/GDP

Source: ERP 2010, Fig 1-3

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Section 1National Income Accounting

Composition of US GDP

Figure: Composition of US GDP

Source: Jones 2008Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Section 1National Income Accounting

Composition of US GDP

WWII led to a dramatic increase in G.Note that C continues on trend, although I collapses.Data Source: FRED

100

101

102

103

YCIG

1930 1935 1940 1945 1950 1955 1960 1965 19700.0

0.2

0.4

0.6

0.8

C/YI/YG/YNX/Y

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Section 1National Income Accounting

Composition of US GDP ...

Source: Jones 2008Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Section 1National Income Accounting

Labor’s Share of GDP

Labor’s share of GDP is roughly constant at around 2/3.

Source: Jones 2008Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Section 1National Income Accounting

Absorption

We call our aggregate spending “absorption”:

A = C + I +G

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Section 1National Income Accounting

Current Account Determination (view 1):

Y −C − I −G = (IM −EX)

Y −A = (IM −EX)

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

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Section 1National Income Accounting

Decomposing G

Break up government expenditure:

G = CG + IG

What is government investment (e.g., in basic research)?

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

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Section 1National Income Accounting

Revised identity:

Y = C + I +G+(IM −EX)

= C + I +CG + IG +(IM −EX)

= CNAT + INAT +(IM −EX)

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

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Section 1National Income Accounting

Current Account Determination (view 2):

Y −CNAT − INAT = (IM −EX)

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

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Section 1National Income Accounting

Current Account Determination (view 3):

SNAT − INAT = (IM −EX)

Alan G. Isaac Macroeconomics: Introduction

Macroeconomics: Questions and MethodsA First Look at Macro Data

Measuring the Macroeconomy

Section 1National Income Accounting

References

[froyen-2005-macrotp] Froyen, Richard T. (2005) Macroeconomics:Theories and Policies. New Jersey: Prentice Hall.

[kuznets-1934-gpo] Kuznets, Simon. (1934) National Income1929--1932. Washington, DC: U.S. Government Printing Office.

[bls-2005-flsforc] of Labor Statistics, Bureau. 2005. ComparativeCivilian Labor Force Statistics, 10 Countries, 1960-2004.

[landefeld.seskin.fraumeni-2008-jep] Landefeld, J Steven, Eugene PSeskin, and Barbara M Fraumeni. 2008. Taking the Pulse of the

Economy: Measuring GDP. Journal of Economic Perspectives 22,193--216.

Alan G. Isaac Macroeconomics: Introduction