revised by khurram shamim khan measuring the economy measure economic activity by –output...

Revised by khurram Shamim Khan

Measuring the Economy

• Measure economic activity by– Output produced, or

– Income earned

• Gross Domestic Product (GDP)– Final products from labor/property located in U.S.

– At market prices

• National Income (NI)– Costs of production, plus

– Profits earned


Measuring the Economy (cont.)

• GDP = C + I + G + (X - M)C = consumption

I = gross private domestic investment

G = government

X = exports

M = imports

• NI = GDP + NR - CC - IBTNR = net factor income from abroad

CC = capital consumption (depreciation allowances)

IBT = indirect business taxes

(X - M) = net exports



• DI = NI + TR + INT - RE - Tp - Tc - INFDI = disposable income (available for spending

by individuals)

TR = transfer payments from government

INT = interest paid on government debt

RE = retained corporate earnings

Tc = corporate tax payments

Tp = personal tax payments

INF = interest on government debt paid to

foreigners



• DI = C + PSPS = personal savings

• I + NFI = PS + BS + GSNFI (net foreign investment) = X - M - INF + NR

BS (business savings) = RE + CC

GS (gov’t savings) = taxes - gov’t outlays

Taxes = Tp + Tc + IBT

Gov’t outlays = G + TR + INT


Indices

• Nominal GDP: i Qit Pit

• Real GDP (period 0 prices): i Qit Pi0

• Implicit price deflator = ratio of real to nominal GDP

• Price index = weighted average of price relatives = It = i wit (Pit / Pio)


Indices (cont.)

• Paasche index: based on current period basket

It = {i Qit Pit} / {i Qit Pi0}

• Laspeyres index: based on base period basket

It = {i Qi0 Pit} / {i Qi0 Pi0}

• Paasche: may understate true inflation rate

• Laspeyres: overstates true inflation rate (because it neglects the fact that people search for cheaper substitutes over time in an inflationary environment)


Indices (cont.)

• Chain-linked index: mixture of Paasche and Laspeyres; quantity weights are from the immediate past period

It = It-1{i Qi,t-1 Pit} / {i Qi,t-1 Pi,t-1}

• Chain-linked measure of rate of real GDP growth (from t-1 to t):

i Qit Pi,t-1} / {i Qi,t-1 Pi,t-1}] - 1


Other Major Price Indices

• Consumer Price Index (CPI): representative basket of consumed goods– Laspeyres-type index

– Issues: overstates true inflation (since Laspeyres); quality improvements, new products

• Producer Price Index (PPI): changes in costs of production– Laspeyres-type index


Data Sources and Presentation

• Sources of data– Product side: surveys and samples

– Income side: tax collection system

• Presentation characteristics– Quarterly data usually shown as annual rates

– Usually seasonal adjustments

– Due to volatility, quarterly growth rates often not best measure with respect to trends in output or inflation


Balance of Payments

• Current account balance = receipts + payments + net transfers– Receipts (a positive entry): by U.S. residents from

abroad

– Payments (a negative entry): made abroad


Business Cycles

• Business cycle: recurring changes in economic activity– No fixed periodic pattern

– Phases (e.g., expansion, recession)• Peak: start of a recession

• Trough: end of a recession

– Leading / coincident / lagging indicators (see lists for specific examples)


Interest Rates

• Yield curve: time to maturity versus yield to maturity– Expectations hypothesis:

(1+r2)2 = (1+r1)(1+Er1)

ri = i-year spot rate (yield)

Er1 = expected future one-year yield

• Real rate of interest:(1+r) / (1+) = (1+rreal)

where is the inflation rate• Fisher relationship: nominal rate = real rate + inflation rate


Exchange Rates• Exchange rate: number of units of foreign currency per dollar• Real exchange rate:

ereal = enominal (P / Pforeign)

P: domestic price level

Pforeign: foreign price level

• Appreciation of U.S. dollar: e (exchange rate) increases; U.S. dollar purchases more foreign currency

• Depreciation of U.S. dollar: e decreases


Growth (cont.)

• Elasticities can also be looked at in terms of total factor returns as shares of output

c = return on capital

w/p = real wage

Y

cKK

Y

Npw

N


Banks (cont.)

• Suppose R=kD, whereR = banking system reservesD = demand depositsk = fraction of deposits held as reserves

• Money supply: M = C + D + T, whereC = currencyT = time (savings) deposits

• Total reserves: TR = RR + RE, whereRR = required reservesRE = excess reserves


Banks (cont.)• Central bank

– Assets = Q + B • Q = securities portfolio; B = loans to banks

– Liabilities = TR + C• TR = total reserves held by banks at central bank (assume

banks do not hold cash reserves); C = currency in circulation

– Balance sheet identity: Q+B = TR+C– Using prior definitions and defining free reserves as

RF = RE - B, then money supply isM = (1/k){Q - (1-k)C - RF} + T

– Note: RF = RF(r,rd), where rd = Fed discount rate– Borrowing: increasing function of r, decreasing

function of rd


Federal Reserve System• Money supply increases when central bank

– Increases its bond portfolio (Q increases)– Reduces its reserve requirements (k decreases)– Reduces the discount rate (rd decreases) (discount

rate is interest rate on Fed loans)

• Structure of system– 1913: Federal Reserve Act– 12 regional banks (each owned by the member

banks)– 7-member Board of Governors– Profits of Federal Reserve banks go to Treasury


Federal Reserve System (cont.)

• Functions of Federal Reserve banks– Examine member banks– Review merger applications– Check-clearing and transfer services– Agent for sale of Treasury securities and distribution

of new currency

• Policy functions– Set discount rate– Discount window (how much borrowing to allow)– Participate on Federal Open Market Committee


Federal Reserve System (cont.)

• Formal Board functions– Approve bank mergers– Set commercial banking activity regulations– Set reserve requirements, discount rate– Direct open market operations


Monetary Policy Tools

• Open market operations– Most actively used tool– Open market purchase of government securities ==>

increases Fed’s portfolio of such securities; paid for by creating reserve deposits ==> increases public’s deposit balances

– Fed Funds rate: rate at which reserve deposits are lent between financial institutions; a market-determined rate

– Purchase securities ==> adds to banking system reserves ==> Fed Funds rate declines

– Sell securities ==> decreases banking system reserves ==> Fed Funds rate increases


Monetary Policy Tools (cont.)

• Discount rate– Increase in rate reduces money supply (due to costly

borrowing from Fed)– Typically, kept 1/4 point below the Fed Funds rate

(allows small banks to use discount window)

• Reserve requirements– Increase in requirement reduces the money supply

(forces banks to hold more in reserve ==> reduce loans, etc.)

– Changes to requirements made infrequently


Fiscal Policy• Fiscal policy tools

– Tax policy• Corporate• Personal

– Expenditure policies• Problems with fiscal policies

– Uncertain responses to policy changes– Lags / delays in implementation

• Recognition lag: between economic disturbance and policymaker recognition

• Decision lag: between recognition and policy decision• Implementation lag: between decision and implementation• Outside lag: between implementation and impact

Insidelags

revised by khurram shamim khan measuring the economy measure economic activity by –output...

Documents

c i g x

q i0 p i0

p io slide

laspeyres index

abroad slide

nominal gdp price index

net exports slide

paasche index