Nominal and Real GDP While nominal GDP is reported every month, most of the interest focuses on the...

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Nominal and Real GDP • While nominal GDP is reported every month, most of the interest focuses on the change in real GDP and the change in prices, known as the implicit deflator • Inflation is also measured by the consumer price index (CPI) and the producer price index (PPI).
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Transcript of Nominal and Real GDP While nominal GDP is reported every month, most of the interest focuses on the...

Nominal and Real GDP

• While nominal GDP is reported every month, most of the interest focuses on the change in real GDP and the change in prices, known as the implicit deflator

• Inflation is also measured by the consumer price index (CPI) and the producer price index (PPI).

Chapter 3

• Key Data Concepts: Inflation, Unemployment, And Labor Costs

Different Measures of Inflation

• Theoretically, there are three different ways the government measures inflation.

• Fixed weight: CPI and PPI

• Implicit deflator: calculated indirectly as current/constant GDP

• Chained deflator: Similar to the implicit deflator, but the base period is reset every year.

Fixed Weight Deflators

• For many years, the standard approach.• However, this method generally overstates

inflation.• If the price of A rises while the price of B falls,

consumers will buy less A and more B, so the actual price index will rise less than indicated by a fixed-weight indicator. Also overstates inflation if consumers shop more at discount stores.

• Also fails to take account of timely introduction of new products, and generally omits quality improvements

Boskin Commission

• Before 1994, CPI overstated inflation by 1.1% per year.

• Interest rates were higher than would have otherwise been the case

• Social security payments rose more rapidly, either causing large deficits or higher tax rates.

• Adjustments since then have eliminated the overstatement.

Implicit Deflators

• Essentially use current weights, so a shift to a lower-priced good or service would cause this index to rise less rapidly than the comparable fixed-weight index.

• Worked fairly well in the pre-computer era• Computer prices fall about 15% per year, according to

government statistics.• Thus over several years, even if the actual amount spent

on computers did not change, the constant-dollar amount would rise sharply and dominate the index.

• As a result, the implicit deflator would understate the true rate of inflation

Chained Deflators

• Because of this drawback, BEA introduced the concept of the chained deflator.

• Current weights are still used, but the base is reset every year, so the extended distortion from many years of declining computer prices is eliminated.

• Theoretically the best measure of inflation, but severe data limitations still apply in terms of measuring the components of GDP.

Could Inflation Be Understated?

• Medical care costs are actually rising faster than the government says.

• Insurance costs are not adequately measured because they are not based on policy premiums, but only the “net” – i.e., the rising cost of accidents is treated as an intermediate service and not counted.

• Higher property taxes are not included, and neither are increases in sales taxes.

What Difference does it make to business managers?

• If inflation is understated, interest rates and wage gains will generally be lower than otherwise.

• However, it may appear that your business is paying more for various goods and services – such as health care – than the average. For this reason the various indexes may not provide valid benchmarks for your costs.

Defining Unemployment

• Concept should be simple: anyone who wants to work but cannot find a job is unemployed.

• But what about an MBA who cannot find a job in finance or consulting and could work flipping burgers, but turns it down. Is that person unemployed?

• Or what about inner city residents who turn down jobs in the suburbs because they don’t have a car to get to the job?

• Or the person who stops looking because they can’t find a job, but would be glad to work if positions were available?

Different Measures of Unemployment

• To try and sort out these issues, two methods of classification of unemployment have been developed.

• The first is theoretical, known as the types of unemployment.

• The second is empirical, known as the degrees of unemployment.

Types of Unemployment

• Seasonal – construction workers laid off in the winters, teachers in the summer, etc. Not included in most published data.

• Frictional – between jobs. Most of these people will soon be re-employed.

• Cyclical – auto or computer workers laid off because of the slump. Generally assumed jobs will resume when the economy improves.

• Structural – due to changing skill needs, these people will probably remain unemployed indefinitely even if the economy prospers.

Degrees of Unemployment

• Long-Term Unemployed. More than 15 weeks.

• Job losers. Excludes those who quit.• Official rate. The rate quoted in the

financial press every month.• Above plus discouraged workers• Above plus marginal workers• Above plus those working part-time for

economic reasons

Discrepancies Between Employment and Unemployment

• Over the long run, the labor force grows about 100,000 per month. Taking this into account, one might expect that the change in unemployment would be equal to the change in employment with the opposite sign plus 100,000.

• In the short run, the two series are not highly correlated. Unemployment is collected from the household survey. Employment is collected from the payroll survey; although an alternative measure is also collected by the household survey, it is generally ignored.

Discrepancies (Slide 2)

• If someone works at two jobs, they are counted as 2 employed people in the payroll survey but only 1 in the household survey.

• If someone is laid off, they may not immediately start looking for work.

• Undocumented aliens are more likely to be counted in the payroll than the household survey.

• New businesses are not included in the payroll employment survey.

The BLS “Fudge Factor”

• That latter point means that the actual data collected from the employment survey would generally underestimate the growth in jobs, so BLS adds a “fudge factor” to provide more accurate estimates.

• However, fewer new businesses are created in recessions, so the fudge factor varies cyclically.

• Eventually, accurate data are obtained from the Censuses of Business, taken once every 5 years. But in the meantime, BLS is simply offering informed guesses about the change in employment.

Different Measures of Labor Market Conditions

• Hours worked per week is a leading indicator• Employment is a coincident indicator• The unemployment rate is a lagging indicator.

That is because when business conditions start to improve, some people who had stopped looking for jobs re-enter the labor force again.

• As a result, the unemployment rate invariably rises during the beginning stages of recovery. By itself, that is NOT a sign that the recovery is weak. That can be better measured by the change in employment.

Duration of Unemployment

• If someone is unemployed for one week, that is far less serious than if they are unemployed for a year.

• Hence the average duration of unemployment is also an important indicator of labor market conditions.

• In recent years, the duration has risen faster than the unemployment rate itself. Once unemployed, it takes longer to find another job.

Interpreting Labor Market Statistics

• Monthly changes in both employment and unemployment are dominated by random factors and erratic seasonal adjustment.

• Generally, a trend in either direction is not apparent until three months have passed.

• The unemployment rate is the most politically sensitive indicator but actually contains the least useful information because it is a lagging indicator.

The Concept of Full Employment

• Generally defined – at least theoretically – when the number of people who are looking for work is equal to the number of jobs vacancies.

• This rate changes over time; in the U.S., it has fluctuated from 3 ½% to 6%.

• Full-employment rate depends on demographic factors and the long-term growth rate; faster growth creates more job opportunities.

• Currently that rate is near 4%.

Unit Labor Costs

• Defined as total compensation – including fringe benefits, bonuses, stock options, etc. – divided by employee-hours.

• Usually tracks very closely with inflation, but in the late 1990s, rose much faster. The result was a decline in profit margins even though the economy was booming.

• It is a better measure of labor market pressures than base wage rates, especially in this era of increasing technology.

Index of Leading Indicators

• Supposed to predict turning points.• Never misses a downturn, but gives many false

signals.• In recent years, dominated by stock market

fluctuations.• Monthly data are erratic, 3 months necessary to

determine a trend.• Useful in the sense you won’t be caught off

guard if a recession does occur; danger is reacting to false signals.

Index of Coincident Indicators

• Consists of employment, industrial production, real business sales, and real personal income excluding transfer payments.

• Does not get much publicity, but a valuable guide of where the economy is right now. More accurate than real GDP, and appears every month.

Seasonally Adjusted Data

• Almost all government data are seasonally adjusted.

• In general that is a worthwhile idea; otherwise data would be dominated by swings such as the surge in sales in December.

• However, seasonal patterns do change over time. Methods to measure these factors are not flawless and sometimes lead to inaccurate data before the glitches are corrected.

Preliminary and Revised Data

• GDP estimates are released for each quarter. The first estimate appears about 30 days after the quarter ends. About 50% of the input for the advance reports are estimated. As a result, that number is often substantially revised.

• Initial reports for employment, production, and retail sales are also based largely on estimated data.

• Data for unemployment and inflation are generally subject to much smaller revisions.