A macroeconomic perspective on the real sectorOutline I. Real Sector Overview II. Measuring and...

A Macroeconomic Perspective on the A Macroeconomic Perspective on the Real Sector: Growth, Economic Real Sector: Growth, Economic ,,

Fluctuations and Inflation Fluctuations and Inflation Introductory Workshop toIntroductory Workshop to

Financial Programming and PoliciesYangon, Myanmar

January 19–23, 2015y ,

Jan GottschalkTAOLAMTAOLAMTAOLAMTAOLAM

IMF-TAOLAM training activities are supported by funding of the Government of Japan

OutlineOutline

I. Real Sector Overview

II. Measuring and Analyzing GDP

III. Sources of Growth

IV. Inflation

V. Forecasting GDP

2This training material is the property of the International Monetary Fund (IMF) and is intended for the use in IMF courses. Any reuse requires the permission of the IMF.

Real Sector OverviewReal Sector Overview

3


What is the real sector about?At one level, it is about

• Level of production in the economythe economy

This means it is also about

• Employment

• Investment

• Income

• Consumption

4


What is the real sector about?At another level, it is about prices such as

• Consumer prices• Consumer prices

• Input prices

• WagesWages

In a market economy, prices clear markets which in turn determineswhich in turn determines production levels. We cannot separate between the two

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the two.


How do we measure economic output?• Should we just add up all the (gross) output produced by businesses and households in the economy?

• No, this would lead to double counting! Example: wheat used in production of bread

T id d bl ti d t bt t• To avoid double counting, we need to subtract intermediate inputs: gross output - intermediate consumption = value added

• Gross domestic product (GDP): sum of value added across all sectors in the economy

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Why is GDP so important?

• Measure of output• Approximation of welfare• Approximation of welfare• Many other variables are moving broadly

proportional to GDP (e g revenues)proportional to GDP (e.g., revenues) GDP ratios GDP forecast is basis for revenue forecasts etc.

• Macroeconomic management: keeping GDP roughly in line with its potential

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Key concepts: ConsumptionWe distinguish between

• Final household consumption e g foodconsumption—e.g., food, housing, transportation• Final government consumption e gconsumption—e.g., electricity, fuel, office supplies

• Intermediate consumption—aforementioned inputs i t d ti

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into production


Key concepts: Investment

Additions to the i l kcapital stock, e.g.,

purchase of machinery ormachinery or construction of buildingsg

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Key concepts: Exports

3030Food Gas

Main Exports(In percent of GDP)

What Myanmar 20

25

20

25

Food Gas

Garments Wood

Other Total Exportsy

sells abroad…

10

15

10

15

5

10

5

10

10

002008 2009 2010 2011 2012


Key concepts: Imports

What you buy from abroad …

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Key concepts: Nominal versus Real

Nominal GDP: measures the value of output of the economy at current pricesy p

Real GDP: measures the value of output of the economy changes in an economy’s physicaleconomy -- 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

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Key concepts: Distinction between nominal versus real is useful for (1) measuring purchasing power:real is useful for (1) measuring purchasing power:

Example: Nominal wages 20%

If inflation was 10%,Real buying power grewReal buying power grew

BUTBUT

If inflation was 30%,

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Real buying power shrank


Key concepts: Distinction between nominal versus real f l f ( ) f d ff fis useful for (2) accounting for different GDP factors:

Value (V) = Price (P) * Quantity (Q)

Nominal GDP (V) = GDP Deflator (P) * Real GDP (Q)

Fundamental relation to be used over & over !

Approximation: ∆%V ≈ ∆%P + ∆%Qpp

Exact relationship:

(1+ ∆%V/100) =(1+∆%P/100)*(1+∆%Q/100)

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(1+ ∆%V/100) =(1+∆%P/100)*(1+∆%Q/100)

OutlineOutline




IV. Inflation

V. Forecasting GDP

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Measuring and Analyzing GDPMeasuring and Analyzing GDP

Goods and services (real flo

Estimate of GDP

Production Approach 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)

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OS=gross operating surpluses of enterprises (including profits, rents, interests)

Labor (real flow) TSP=taxes less subsidies


Production approach: GDP Shares

45%

Composition of GDP (Constant 2010/11 Prices)

35%

40% Agriculture

25%

30%Industry (incl. mining & construction)

Services and trade

20%

%

2008

2009

2010

2011

2012

2013

Services and trade

17

8/09

9/10

0/11

1/12

2/13

3/14


Production approach: real GDP growth by sector

12%

14%

GDP Growth (Constant 2010/11 Prices)

8%

10%

12%

GDP (constant 2010/11 prices)

Agriculture

4%

6%Agriculture

Industry (incl. mining & construction)

S i d d

0%

2%

200

201

201

201

201

Services and trade

18

09/10

10/11

11/12

12/13

13/14


Production approach: growth contributions by sector

8%

9%

GDP Growth (Constant 2010/11 Prices)

5%

6%

7%

Services and trade

Industry (incl. mining &

2%

3%

4%dus y ( c g &

construction)

Agriculture

GDP (constant 2010/11

0%

1%

2009

2010

2011

2012

2013

GDP (constant 2010/11 prices)

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9/10

0/11

1/12

2/13

3/14


Expenditure approach:

Absorption (A) = Final Consumption (C) + Investment (I) p ( ) ( )

Net Exports (X-M)p ( )X = Exports of goods and servicesM = Imports of goods and services

GDP = A + X – MD ti D d F i D d

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Domestic Demand Foreign Demand


Fiscal Policies

Real Sector

G; TPoliciesSector

Monetary financing/ h

Monetary financingInterest rates/exchange

rateCA=S-I

MonetaryPolicies

Balance of Payments RM=NFA+NDC

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OutlineOutline




IV. Inflation

V. Forecasting GDP

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Sources of GrowthSources of Growth

A simple metaphor for thinking about growth:Economy as a machine: Transforming inputs such as labor

and capital into outputs such asand capital into outputs such as goods and services.

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‘Economy as machine’ metaphor suggests …

… for more growth we need more inputs!

hBut many inputs such as land, labor or education are difficult

growth in the short run

to procure in the short run, so …

… growth in the short run depends really on investment.

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Is this really true?


Alternatively, we need to use our existing inputs more efficiently!efficiently!This is about …

• Technical innovation (especially in advanced countries), and …• … adoption of best practices and existing technologies (especially

din emerging and developing countries)

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Growth accounting—quantifying growth factorsGrowth accounting is based on production function that typically includes the following growth factors:

G h f i l hi h i l l li k d i ’• Growth rate of capital, which is closely linked to a nation’s investment rate

• Growth rate of ‘Raw’ labor, i.e., growth in labor forceGrowth rate of Raw labor, i.e., growth in labor force measured in the number of available workers

• Growth of human capital, i.e., growth in the quality of i di id l k f li k d h liindividual workers, often linked to schooling

• Technical progress, i.e., increase in efficiency of using above input factors, often called growth rate of total factor

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input factors, often called growth rate of total factor productivity (TFP)


Growth accounting—advanced economiesSo what are typically the most important growth drivers?

For advanced economies, TFP growth is often key:

27Source: See DeLong, Growth Accounting, http://j-bradford-delong.net/macro_online/growth_accounting.pdf, p. 6


Growth accounting—transition economies

• Capital deepening was on average thewas on average the single most important growth driver

• Closely followed by TFP growth

28Source: See Iradian (2007), Rapid Growth in Transition Countries: Growth-Accounting Approach, p. 16


Growth Experience in Asial d ll l• Capital deepening was especially important in Asia, resulting

from very high investment (and savings) ratios• Human capital accumulation was another key factor in EastHuman capital accumulation was another key factor in East Asia during 1966-90

29Source: See Young (1994), Tyranny of Numbers, p. 3


Recent IMF ResearchRecent IMF Research Results on Growth FactorsFactors

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Investment is associated with higher growth …2 R l I ( f GDP)

20

25 Real Investment (percent of GDP)

10

15

5

10

0t [–4,0] t [1,5]* t [6,10]**

LICs ith strong gro th

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LICs with strong growthLICs with weak growth


… and FDI appears especially beneficialN t F i Di t I t t Fl

4

Net Foreign Direct Investment Flows(percent of GDP)

2

3

0

1

0t [–4,0]*** t [1,5]* t [6,10]**

LICs with strong growth

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LICs with weak growth


Growth takeoffs are associated with openness:R l E ( f GDP)

3035

Real Exports (percent of GDP)

152025

05

10

0t [–4,0] t [1,5] t [6,10]**

LICs with strong growth

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LICs with weak growth


Reigning in high inflation promotes growth:2 I fl i (1990 2011)

20

25 Inflation (1990-2011)

10

15

0

5

[ 4 0]*** [1 5] [6 10]**t [–4,0]*** t [1,5] t [6,10]**

LICs with strong growthLICs with weak growth

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g


Quality of institutions and governance is another important growth factoranother important growth factor

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36Source: See Kaufmann and Kray, Growth Without Governance, p. 40


What does this imply for Myanmar?Myanmar’s growth performance in coming years should benefit from• Ongoing transition to market economy• Ongoing transition to market economy efficiency gains• Greater trade integrationg efficiency gains, innovation• Public sector reforms quality of institutions quality of institutions• Boost to education and health spending human capital formation

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p

OutlineOutline




IV. Inflation

V. Forecasting GDP

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InflationInflation

What is inflation?• Inflation is a sustained increase

in the overall price level

– Increase in average prices of all goods and services vs. change in relative prices of individual goods and services

S i d i– Sustained increase vs. one-time increase in the price level

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InflationInflation

Why do we care about inflation?• Reasonably low inflation is equivalent to price stability key element of macroeconomic stabilitymatters for growthmatters for growth

• High inflation has adverse impact especially on poor• Many macroeconomic variables have a price component,Many macroeconomic variables have a price component,

for example:

l l * flNominal GDP = Real GDP * GDP Deflator

Inflation helps understanding the price component

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Inflation helps understanding the price component

InflationInflation

Inflation determinants

Π (Price Inflation)

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InflationInflationInflation determinants in Myanmar:reserve money matters …y

40%

45%

35%

40%

Reserve Money & Headline CPI (Y-o-Y Change in %)

25%

30%

35%

20%

25%

30%

10%

15%

20%

25%

5%

10%

15%

20% CPI (headline, 2010=100)

Reserve money (right axis)

0%

5%

10%

-5%

0%

5%

Ja Ju Ja Ju Ja Ju Ja Ju Ja Ju Ja Ju Ja Ju

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n-08

l-08

n-09

l-09

n-10

l-10

n-11

l-11

n-12

l-12

n-13

l-13

n-14

l-14

InflationInflation

… and so do international commodity prices:

60%

80%

35%

40%

Commodity Prices & Headline CPI (Y-o-Y Change in %)

CPI (headline

20%

40%

20%

25%

30%CPI (headline, 2010=100)

-20%

0%

5%

10%

15%All Commodity Price Index, 2005 = 100, includes

-60%

-40%

-5%

0%

Jan-0

Aug-

Mar

Oct -

May

Dec-

Jul-1

Feb-

Sep-

Apr-

Nov-

Jun-

both Fuel and Non-Fuel Price Indices

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08 -08

-09

-09

y-10

-10

11 -12

-12

-13

-13

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InflationInflationThe role of the exchange rate becomes visible when we consider quarterly inflation rates:

15%

20%

4%

5%

Exchange Rate & Headline CPI (Q-o-Q Change in %)

0%

5%

10%

1%

2%

3%

CPI (headline, 2010=100)

15%

-10%

-5%

0%

-2%

-1%

0%

Exchange rate (lead 2, right axis)

-25%

-20%

-15%

-5%

-4%

-3%

Ja Ju No

Ap Se Fe Ju D e M Oc

M A u Ja Ju

axis)

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n-09

n-09

ov-09

pr-10

ep-10

eb-11

l-11

ec-11

ay-12

ct-12

ar-13

ug-13

n-14

n-14

OutlineOutline




IV. Inflation

V. Forecasting GDP

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Forecasting GDPForecasting GDP

Why does forecasting GDP matter?

• GDP forecast is the starting point for many other forecasts, e.g., revenues or imports• Similarly, GDP forecasts are necessary for projecting GDP ratiosfor projecting GDP ratios• GDP forecasts are central for macroeconomic management

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It’s difficult …• It’s very rare that the forecast hits exactly the mark (if so it’s just luck!)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 asforecast is often as important

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General procedure• Start with analyzing the past what were key developments and how are they going to affectand 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 policypast and present, taking policy (changes) into account

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Remember distinction between nominal and real:

Nominal GDP: measures the value of output of the economy at current pricesy p

Real GDP: measures the value of output of the economy changes in an economy’s physicaleconomy -- changes in an economy s physical output -- using prices of a fixed base year

GDP deflator: price component of GDP, computed as Nominal GDP/Real GDP

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Typical forecasting approach:

Start with forecasting real GDP Forecast inflation Forecast inflation Forecast GDP deflator as function of inflation

f tforecast Compute

Nominal GDP = Real GDP x GDP Deflator

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Forecasting Real GDPForecasting Real GDP

Various approaches for forecasting real GDP:

Forecast– Potential output and output gapPotential output and output gap– Supply-side approach:

• Production function • Sectoral forecasts

– Demand-side approach: ppforecast expenditures (C + I + X - M)

– Reconciliation of Supply & Demand

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Forecasting Real GDPForecasting Real GDP——Potential GDP & Output GapPotential GDP & Output Gapp pp p

Positive output gap:demand > supply

Negative output gap:demand < supply

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Forecasting Real GDPForecasting Real GDP——Production Function ApproachProduction Function Approach

Q = f (K, L, A)

pppp

Q ( , , )where K = Capital

L LaborL = LaborA = Technology, Institutions

In the long run, increasing supply requires increasing A (through structural policies)increasing A (through structural policies)

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Forecasting Real GDPForecasting Real GDP——Sectoral ForecastsSectoral Forecasts

Supply-side: sectoral forecasts

Forecast production in each sector separately as they may have different determinants, then add up the individual forecasts to , pobtain the total:

Let’s practiceLet s practice this!

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Forecasting Real GDPForecasting Real GDP——Demand ApproachDemand Approach

Demand-side: forecasting expendituresGDP = (C + C ) + (I + I ) + (X – M)GDP = (CP + CG) + (IP + IG) + (X M)

Fiscal sector BOPWe should be able to forecast public consumption and investment (CG & IG) using information from the budgetWe might be able to construct forecast equations for exports and imports (X – M) [External sector]Private consumption (CP) is often fairly steady and not that difficult to forecast

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Leaves private investment (IP) as a very difficult element to forecast because this tends to be fairly volatile

Forecasting GDP DeflatorForecasting GDP Deflator

Real

Consumption Consumption

Deflator = Nominal

Consumption

Real

Investment =Nominal

Investment Deflator = Investment

Real Exports

Export Deflator =

Nominal Exports

Real Imports

Import Deflator =

Nominal Imports

Real GDP Nominal GDP

Nominal GDPGDP Deflator 100

Real GDP

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Forecasting Components of GDP DeflatorForecasting Components of GDP Deflator

Consumption: %∆ PC = %∆ CPIp C Investment: %∆ PI = (1-a) %∆ CPI + a %∆ PM

(a = share of imported investment goods)

Export:%∆ PX = ((1+%∆ Export price in US$/100) *(1 %∆ E h /100) 1) *100(1+%∆ Exchange rate/100) –1) *100

Import:%∆ P ((1+%∆ I t i i US$/100) *%∆ PM = ((1+%∆ Import price in US$/100) *(1+%∆ Exchange rate/100) –1) *100

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Forecasting Nominal GDPForecasting Nominal GDP

Putting it all together: • Forecast real GDP growth• Forecast GDP deflator

• Compute nominal GDP growth, using

Valuet+1 = Valuet (1+%P) (1+%Q)

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Forecasting GDPForecasting GDP——Other SourcesOther Sources

Forecasting tools

CCompare your own forecasts to those of the IMF!the IMF!

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OutlookOutlook

Next, we will explore in more detail …• … the fiscal sector, which helps with analyzing public consumption and investment (CG & IG)

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A macroeconomic perspective on the real sectorOutline I. Real Sector Overview II. Measuring and...

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