Revised by khurram Shamim Khan Measuring the Economy Measure economic activity by –Output...
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Transcript of 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
Revised by khurram Shamim Khan
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
Revised by khurram Shamim Khan
Measuring the Economy (cont.)
• 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
Revised by khurram Shamim Khan
Measuring the Economy (cont.)
• 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
Revised by khurram Shamim Khan
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)
Revised by khurram Shamim Khan
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)
Revised by khurram Shamim Khan
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
Revised by khurram Shamim Khan
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
Revised by khurram Shamim Khan
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
Revised by khurram Shamim Khan
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
Revised by khurram Shamim Khan
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)
Revised by khurram Shamim Khan
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
Revised by khurram Shamim Khan
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
Revised by khurram Shamim Khan
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
Revised by khurram Shamim Khan
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
Revised by khurram Shamim Khan
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
Revised by khurram Shamim Khan
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
Revised by khurram Shamim Khan
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
Revised by khurram Shamim Khan
Federal Reserve System (cont.)
• Formal Board functions– Approve bank mergers– Set commercial banking activity regulations– Set reserve requirements, discount rate– Direct open market operations
Revised by khurram Shamim Khan
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
Revised by khurram Shamim Khan
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
Revised by khurram Shamim Khan
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