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Analyzing the Real Analyzing the Real SectorSector
OverviewJan Gottschalk
TAOLAM
This training material is the property of the IMF – Singapore Regional Training Institute (STI) and is intended for the use in STI courses. Any reuse requires the permission of the STI.
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
I. Growth
OverviewOverview
II. GDPIII. InflationIV. Nominal vs. RealV. Forecasting GDP
1. Forecasting Real GDP2. Forecasting Inflation3. GDP Deflator4. Putting It Together: Nominal GDP Forecasts
2
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
I. GrowthI. GrowthThe Long View
Figure: Evolution of GDP 1000-2000
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Economic Growth and Income DifferencesEconomic Growth and Income Differences
Figure: The evolution of income per capital 1960-2000
3
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
GDP Growth at Constant Prices, per Capita GDP Growth at Constant Prices, per Capita GDP Growth per Capita (Constant LCU, Change in %)
Economic Growth inEconomic Growth in Myanmar & ThailandMyanmar & Thailand
-5%
0%
5%
10%
15%
MyanmarThailand
-15%
-10%
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
2012
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
GDP at Constant Prices, per Capita GDP at Constant Prices, per Capita GDP per Capita (Constant LCU, 1960=100)
200 0300.0400.0500.0600.0700.0800.0900.0
1,000.0
MyanmarThailand
0.0100.0200.0
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
4
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Compare GDP at Current Prices, US Compare GDP at Current Prices, US dollars, per Capita :dollars, per Capita :
GDP per Capita in US Dollars
2 000
3,000
4,000
5,000
6,000
GDP per Capita in US Dollars
MyanmarThailand
0
1,000
2,000
2009 2010 2011
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Growth and Business CyclesGrowth and Business Cycles
5
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
How do we explain growth?How do we explain growth?
Laborof
tion
CapitalPhysical
Human
Fact
ors
Prod
uct
ProductivityTechnology
Institutions
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Sources of GrowthSources of Growth——Innovation of Technology Innovation of Technology & Products& ProductsInnovation is a broad
t iconcept, encompassing adoption of best practices, new technology, and developing new products. It is also a search process with many failures and few small successes that move the economy forward.
6
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Market Economy Fosters Innovation & Growth Market Economy Fosters Innovation & Growth But Is ComplexBut Is ComplexPrices are key coordination mechanism for a market economy;price stability works best in context of
imacroeconomic stability.
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Price Signals are Central for Market Economy Price Signals are Central for Market Economy But Easily Washed OutBut Easily Washed OutPrice mechanismPrice mechanism works best against a background of stable prices, i.e., low inflation and stable exchange rate.
7
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
IMF Research Results on Growth FactorsIMF Research Results on Growth Factors
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Investment is associated with Investment is associated with higher growth …higher growth …
Real Investment (percent of GDP)25 p
10
15
20
LICs with strong growthLICs with weak gro th
0
5
t [–4,0] t [1,5]* t [6,10]**
growth
8
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
… and FDI appears to be especially beneficial… and FDI appears to be especially beneficial
Net Foreign Direct Investment gFlows
(percent of GDP)
2
3
4
LICs with strong growthLICs with weak
0
1
t [–4,0]*** t [1,5]* t [6,10]**
growth
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Growth takeoffs are associated with opennessGrowth takeoffs are associated with openness
Real Exports (percent of GDP)
1520253035
LICs with strong growthLICs with weak
05
10
t [–4,0] t [1,5] t [6,10]**
LICs with weak growth
9
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Reining in high inflation promotes growthReining in high inflation promotes growth
25
10
15
20
25
LICs with strong growthLICs with weak
Inflation (1990-2011)
0
5
t [–4,0]*** t [1,5] t [6,10]**
growth
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
II. GDP II. GDP
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Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Measure of output
Why Is GDP so Important?
• Measure of output• Approximation of welfare• Many other variables are moving broadly
proportional to GDP (e.g., revenues) GDP ratios GDP forecast is basis for revenue forecasts etc.M i k i GDP hl• Macroeconomic management: keeping GDP roughly in line with its potential
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Gross output: value of all goods produced in the economy (double counting; example of wheat used in
What is GDP and How Do We Measure It?
economy (double counting; example of wheat used in production of bread)
Value added (VA): gross output minus intermediate consumption (eliminates double counting)
Gross Domestic Product (GDP): sum of value added across all sectors of the economy. Measures the value of final goods and services
Consumption: can be intermediate (inputs into production) and final (goods and services used byproduction) and final (goods and services used by households and government sector)
Gross investment (also called gross capital formation): additions to the physical stock of capital in the economy, such as building of machinery, facilities
11
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Goods and services (real flo
Estimate of GDP
Production ApproachMoney (financial flow) ( sectoral "value added") Money (financial flow) ( sectoral value added )
"Goods Market" Expenditure Approach ( Y = C + I + X - M )
HOUSEHOLDS PRODUCERS
"Factors Market"
NON-RESIDENTS
Income Approach (Y = wages + OS+TSP)
Wages (financial flow)
OS=gross operating surpluses of enterprises (including profits, rents, interests)
Labor (real flow) TSP=taxes less subsidies
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Production Approach: GDP SharesProduction Approach: GDP SharesComposition of GDP (Constant 2006/07 Prices)
5%10%15%20%25%30%35%40%45%50%
Agriculture
Mining and Energy
Industry & construction
0%5%
2005/06
2006/07
2007/08
2008/09
2009/10
2010/11
2011/12
Services and trade
12
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Growth by SectorGrowth by Sector
GDP Growth (Constant 2006/07 Prices)
5%
10%
15%
20%
25%GDP Growth (Constant 2006/07 Prices)
GDP (constant 2006/07 prices)Agriculture
Mining and Energy
0%
5%
2005/06
2006/07
2007/08
2008/09
2009/10
2010/11
2011/12Industry & constructionServices and trade
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
GDP Growth Contributions by SectorGDP Growth Contributions by SectorGDP Growth (Constant 2006/07 Prices)
4%
6%
8%
10%
12%
14%
Services and trade
Industry & constructionMining and Energy
0%
2%
2005/06
2006/07
2007/08
2008/09
2009/10
2010/11
2011/12
Agriculture
GDP (constant 2006/07 prices)
13
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Absorption (A) Final Consumption (C) +
GDP from the Expenditure Side
Absorption (A) = Final Consumption (C) + Investment (I): A = C + I
Net Exports (X-M)X = Exports of goods and servicesM = Imports of goods and servicespo ts o goods a d se ces
GDP = A + X – MDomestic Demand Foreign Demand
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Final consumption (C)Households: food electricity cars mobile phones
GDP from the Expenditure Side—Examples:
Households: food, electricity, cars, mobile phones, etc.Government: ‘goods & services’ in recurrent budget both imported & locally produced goods Investment (I)
Machines, equipment both imported & locally produced goods
Exports (X)Exports (X)garments, rice, jade etc. Imports (M)
Cars, mobile phones, machines, equipment (see above)
14
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
3030
Main Exports(In percent of GDP)
10
15
20
25
30
10
15
20
25
30Food Gas
Garments Wood
Other Total Exports
0
5
0
5
2008 2009 2010 2011 2012
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Inflation is a sustained increase in the overalli l l
III. InflationIII. Inflation
price level◦ Increase in average prices of all goods and services vs.
change in relative prices of individual goods and services◦ One-time increase in the price level vs. underlying inflation
Commonly used measures include changes in:y g− The consumer price index (CPI)− Wholesale (WPI) oror Producer Price Index (PPI)− The GDP deflator (PGDP)
15
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Reasonably low inflation is equivalent to price stability
Why Do We Care About Inflation?
stability key element of macroeconomic stability matters for growth
Many macroeconomic variables have a price component, e.g.Nominal GDP Real GDP * GDP DeflatorNominal GDP = Real GDP * GDP Deflator Inflation helps understanding the price component
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Inflation DeterminantsInflation Determinants
Π (Price Inflation)
16
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Nominal GDP: measures the value of output of the economy at current prices
IV. Nominal IV. Nominal vs. Realvs. Real
of the economy at current prices Real GDP: measures the value of output of
the economy -- changes in an economy’s physical output -- using prices of a fixed base year Changes in nominal GDP over time reflect
changes in both prices and physical output
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Distinction Between Nominal & Real Is Useful For (1) Purchasing Power
If inflation was 10%,Real buying power grew
BUT
If inflation was 30%,Real buying power shrank
17
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Distinction Between Nominal & Real Is Useful For (2) Accounting for Different Determinants
Fundamental relation to be used over & over !
Approximation: ∆%V ≈ ∆%P + ∆%Q
Nominal GDP (V) = GDP Deflator (P) * Real GDP (Q)
Exact relationship:(1+ ∆%V/100) =(1+∆%P/100)*(1+∆%Q/100)
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
V. Forecasting GDPV. Forecasting GDPWhy does forecasting GDPWhy does forecasting GDPmatter?• GDP forecast is the starting point for many other forecasts, e.g., revenues or imports• Similarly, GDP forecasts are
f j i GDPnecessary for projecting GDP ratios• GDP forecasts are central for macroeconomic management
18
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
It’s difficult …It’s difficult …• It’s very rare that the f hi l hforecast hits exactly the mark (if so, it’s just luck!)• The forecast ‘number’ is important (e.g., for the budget), but …• … the ‘story’ behind the forecast is often as important
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
General Procedure• Start with analyzing the
h kpast what were key developments and how are they going to affect the present and future?• What do we know about the present (nowcast)?• Forecast is an extrapolation of past and present, taking policy (changes) into account
19
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Forecasting Real GDP (volume)
Specific Procedure
◦ Potential output and output gap◦ Supply: Production function Sectoral forecasts◦ Demand: expenditures (C + I + X - M)◦ Reconciliation of Supply & Demand Forecasting Inflation (prices) Obtaining Nominal GDP Forecast
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
V.1 Forecasting Real GDPPotential Output & Output Gap
• Potential GDP is the level of output that can be sustainably produced without adding or subtracting inflation pressures. That is, demand and supply are broadly in balance.
• Output gap: The difference between actual and potential GDP.
• Output gap may be positive or negative. − A positive output gap would signify an expansion that could
place excessive pressure on resources.− A negative output gap signifies idle resources—low capacity
utilization of capital stock and higher unemployment—that is likely to lead to declining rates of inflation or deflation.
20
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Output Gaps
Positive output gap:demand > supply
Negative output gap:d d ldemand < supply
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Q = f (K L A)
Supply Side: Production Function Approach for Forecasting Potential Growth
Q = f (K, L, A)where K = Capital
L = LaborA = Technology, Institutions
In the long run, increasing supply requires increasing A (through structural policies)
21
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Production Approach to GDP:
Forecast production in each sector separately as they
Supply Side: Sectoral Forecasts
Forecast production in each sector separately as they may have different determinants, then add up the individual forecasts to obtain the total:
...,
1,
,
1,
,
1,1
tser
tserser
tman
tmanman
tagr
tagragr
t
t
GDP
GDPw
GDP
GDPw
GDP
GDPw
GDP
GDP
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
GDP = (CP + CG) + (IP + IG) + (X – M)Demand Side: Forecasting Expenditure
Fiscal sector BOP
We should be able to forecast public consumption and investment (CG & IG) using information from the budget. We might be able to construct forecast equations for exports and imports (X – M) [External sector]
Fiscal sector BOP
Private consumption (CP) is often fairly steady and not that difficult to forecastLeaves private investment (IP) as a very difficult element to forecast because this tends to be fairly volatile
22
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
V.2 Forecasting Inflation
Why does forecasting inflationWhy does forecasting inflationmatter?• Inflation forecast is the starting point for the price component of many other forecasts, e.g., GDP deflator
K i i fl i d l• Keeping inflation under control is central macroeconomic objective, which requires inflation forecast
The Simplest Inflation ForecastUses only past data on CPI or inflation as input …
R iRequires: Reliable CPI data Basic techniques in
data analysis / Excel skills
Advantage: Simple In the short-term,
hard-to-beat fforecast
Disadvantage: Doesn’t help with
monetary policy formulation
Structural breaks are major problem
23
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Probably not too
For Myanmar It Could Look Like This …
Trend CPI in Myanmar (Example)bad as a forecast, but …• based on a number of arbitraryassumptions, and• not useful for 50.0
100.0
150.0
200.0
250.0y ( p )
analysis of causes of inflation
0.0 1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
CPI (Index, eop) Trendline
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Core vs non-core inflation
Adding Content to the Inflation Analysis—General Considerations
(e.g., non-food vs food inflation) Overall demand conditions Exchange rates Imported prices Expectations
24
A Simple Way to Identify Inflation Factors: Decomposition Into Core and Non-Core InflationUses only past data on CPI or inflation and its components as input …
R iRequires: Reliable CPI data
on headline inflation and its components
Basic techniques in data analysis / Excel skills
Advantage:Si l Simple
InformativeDisadvantage: It is still silent on
role of monetary policy for inflation
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
For Myanmar It Could Look Like This …
10.0%Contributions of Food and Non-Food Inflation
0.0%
2.0%
4.0%
6.0%
8.0%
Non-foodFoodInflation (eop)
-6.0%
-4.0%
-2.0%
2008 2009 2010 2011 2012
25
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Inflation Forecast: Practical ApproachWhen data is not extensively available --Inertial Approach (with judgmental adjustment): 1t t tX
• How and why would inflation rate be different from the previous year?
X: judgmental adjustment
Expected cost pressures:W ld d i h h i diWorld trade prices, exchange rate changes, wages, indirect taxes
Expected policy and other demand changes:Changes in fiscal or monetary policy stance, slowdown in consumption due to rising unemployment, negative expectations
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
V.3 GDP Deflator
Real
Consumption =
Nominal Consumption Deflator
=Consumption
Real Investment
Investment Deflator
= Nominal
Investment
Real Exports
Export Deflator
= Nominal
Exports
Real Imports
Import Deflator
= Nominal
Imports
Real GDP Nominal GDP
Nominal GDPGDP Deflator 100
Real GDP
26
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Decomposing GDP deflator into its components
Forecasting GDP Deflator
%∆PGDP = WC %∆PC + WI %∆PI
+ WX %∆PX - WM %∆PM
WC = consumption share in GDP
WI = investment share in GDP
WX = export share in GDP
WM = import share in GDP
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Consumption: %∆ PC = %∆ CPI Investment: %∆ PI = (1-a) %∆ CPI + a %∆ PM
Forecasting Component Deflators
Investment: %∆ PI (1 a) %∆ CPI + a %∆ PM
(a = share of imported investment goods)
Export:%∆ PX = ((1+%∆ Export price in US$/100) *(1+%∆ Exchange rate/100) –1) *100
Import:Import:%∆ PM = ((1+%∆ Import price in US$/100) *(1+%∆ Exchange rate/100) –1) *100
27
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
Forecast real GDP growth Forecast prices
V.4 Putting It Together: Nominal GDP Forecast
p◦ CPI◦ Sub-components of GDP deflators (CG, IP , IG)◦ GDP deflator
Compute nominal GDP growth, using
Value = Value (1+%P) (1+%Q)Valuet+1 = Valuet (1+%P) (1+%Q)
Central Bank of Myanmar - TAOLAM“Introduction to Financial Programming”
December 16-20, 2013 Yangon, Myanmar
CONGRATULATIONS!
You are now well on your way to forecasting GDP and Inflation on
your OWN!
Thank you!