Measuring the US Economy
FIN 30220: Macroeconomics
U.S. GDP of $17 Trillion represents approximately one fifth of total worldwide production ($108 Trillion) and makes the United States the largest single country economy on the planet!!
0
2
4
6
8
10
12
14
16
18
20
* Source: CIA FactbookNote: 2014 GDP estimates measured on a Purchasing Power Parity Basis
Trill
ions
of D
olla
rs
GDP is the standard benchmark for economic well being. Is it a good indicator of well being?
VS
0
10
20
30
40
50
60
70
GDP Real GDP Real Per CapitaGDP
Real MedianHousehold Income
1950: $275B
2014: $17,555B
1950: $2,200B
2014: $16,200B
1950: $15,000
2014: $50,000
1950: $27,000
2014: $52,000
Rat
io
2009 Dollars 2012 Dollars2009 Dollars
GDP is the standard benchmark for economic well being. Is it a good indicator of well being?
VS
Annual defense spending has grown from $35B in 1950 to $795B in 2009. Should this be subtracted out?
The service industry has grown from 30M employees in 1950 to 113M in 2009. Is this really “new activity”?
Should we count things like pollution as economic “bads”? How do we account for the added quality and convenience of new products and technologies?
*Source: Rethinking Progress
The Genuine progress indicator, or GPI, is a metric that has been suggested to replace, or supplement, gross domestic product (GDP) as a measure of economic growth. GPI is designed to take fuller account of the health of a nation's economy by incorporating environmental and social factors which are not measured by GDP.
The Satisfaction with Life Index was created by Adrian G. White, an analytic social psychologist at the University of Leicester, using data from a metastudy. It is an attempt to show life satisfaction in different nations.
Country SWL
#1 Denmark 273.33
#1 Switzerland 273.33
#3 Austria 260
#3 Iceland 260
#5 Bahamas 256.67
The US is ranked #23 with a score of 246.67 (tied with the United Arab Emirates and Venezuela)
China is ranked #82
Firms Households
Product Markets
Factor Markets
The Basic circular flow – real goods and services
Firms supply households with final goods
Households supply labor and capital to firms
To understand the US economy, we need to visualize how goods, services, and payments flow between sectors of the economy.
Firms Households
Product Markets
Factor Markets
Every flow of real goods and services is matched by an equal flow of payments in the opposite direction
Households Pay for goods and services
Firms pay wages, interest, profits
Households supply labor and capital to firms
Firms supply households with final goods
Firms Households
Factor Markets
Product Markets
Let’s leave out the flow of real goods for simplicity…the basic circular flow is payments from households to firms (payment for final goods and services) and from firms to households (payment for factor services). However, keep in mind that there has to be an equal flow in the opposite direction of real goods and services.
Firms Households
Factor Markets
Product Markets
Financial Markets
Now, we can add the financial sector (acting as a middleman between businesses and firms)
Net Household savings
Borrowing and stock issues by firms
Investment spending
Firms Households
Factor Markets
Product Markets
Financial Markets
Government
Now, add the public sector
Government Borrowing
Government Spending
Taxes
Transfers
Firms Households
Factor Markets
Product Markets
Financial Markets
Rest of WorldGovernment
Foreign Borrowing
Foreign Lending
Exports Imports
Now, add rest of the world
Firms Households
Product Markets
Rest of WorldGovernment
Exports Imports
Gross domestic product (GDP) measures the current market value of all goods and services produced within the borders of a country over a given time period.
For the US, GDP (on an annual basis) for the first quarter of 2015 was $17,655B
Therefore, in measuring GDP, we are concentrating on the product markets
Farmer A produces 1,000 bushels of Apples (Apples cost $10/bushel)
Farmer B produces 2,000 bushels of Oranges (Oranges costs $15/bushel)
Calculating GDP – a simple example. GDP Calculation
Farmer A:
1,000 Bushels@ $10/Bushel $10,000
Farmer B:
2,000 Bushels@ $15/Bushel $30,000
GDP $40,000
Suppose that Intel produces 1,000 computer chips (P = $100)
1000 Chips sold to Dell
Dell produces 1000 computers (P = $2,000)
Calculating GDP – the problem with intermediate goods.
GDP Calculation
1,000 computer chips @ $100
1,000 computers @ $2,000
$100,000
$2,000,000
GDP $2,100,000
Houston, we have a problem!
Suppose that Intel produces 1,000 computer chips (P = $100)
1000 Chips sold to Dell
Dell produces 1000 computers (P = $2,000)
The problem with intermediate goods is that they create a “double counting” problem.
Intel reports the value of the computer chips they produced Dell also reports the value of the computer
chips (as a part of the computers they produced)
We have counted the computer chips twice!
Suppose that Intel produces 1,000 computer chips (P = $100)
1000 Chips sold to Dell
Dell produces 1000 computers (P = $2,000)
Value added measures the value of the final product minus the value of all the materials that went into that final product
GDP Calculation (Value Added)
1,000 computer chips @ $100
1,000 computers @ $2,000
$100,000
$2,000,000
GDP $2,000,000
- $100,000Materials Expense
Suppose that Intel produces 1,000 computer chips (P = $100)
1000 Chips sold to Dell
Dell produces 500 computers (P = $2,000)
Lets change the example up a bit… GDP Calculation (Value Added)
1,000 computer chips @ $100
500 computers @ $2,000
$100,000
$1,000,000
GDP $1,000,000
- $100,000Materials Expense
Dell has 500 chips remaining in inventories
Is this correct?
Suppose that Intel produces 1,000 computer chips (P = $100)
1000 Chips sold to Dell
Dell produces 500 computers (P = $2,000)
Any materials purchased that haven’t been used need to be added back in as an investment expense GDP Calculation
(Value Added)
1,000 computer chips @ $100
500 computers @ $2,000
$100,000
$1,000,000
GDP $1,050,000
- $100,000Materials Expense
Dell has 500 chips remaining in inventories
Inventory Investment $50,000
Suppose that Xerox produces 50 copiers (P = $5000)
50 Copiers sold to Dell
Dell produces 1000 computers (P = $2,000)
Lets change things up again…. GDP Calculation (Value Added)
50 copiers @ $5000
1,000 computers @ $2,000
$250,000
$2,000,000
GDP $2,000,000
- $250,000Equipment expense
Is this right?
Suppose that Xerox produces 50 copiers (P = $5000)
50 Copiers sold to Dell
Dell produces 1000 computers (P = $2,000)
Dell now owns an asset (the copier) which needs to be added back in GDP Calculation
(Value Added)
50 copiers @ $5000
1,000 computers @ $2,000
$250,000
$2,000,000
GDP $2,250,000
- $250,000Equipment expense
Equipment Investment $250,000
Gross Domestic Product vs. Net Domestic ProductGross of depreciation expense
Net of depreciation expense
50 copiers @ $5000
1,000 computers @ $2,000
$250,000
$2,000,000
GDP $2,250,000
- $250,000Equipment expense
Equipment Investment (full value)
$250,000
50 copiers @ $5000
1,000 computers @ $2,000
$250,000
$2,000,000
NDP $2,225,000
- $250,000Equipment expense
Equipment Investment (depreciated value)
$225,000
Gross Domestic Product vs. Net Domestic ProductGross of depreciation expense
Net of depreciation expense
50 copiers @ $5000
1,000 computers @ $2,000
$250,000
$2,000,000
GDP $2,250,000
- $250,000Equipment expense
Equipment Investment (full value)
$250,000
GDP $2,250,000Depreciation -$25,000
NDP $2,225,000
For the US• GDP = $17.6T• NNP = $15.1T• Capital Stock = $41T
Depreciation = $2.5T (6%)
Lets put is all together…
Suppose that Intel produces 1,500 computer chips (P = $100)
Suppose that Xerox produces 50 copiers (P = $5000)
200 Chips bought by households
1,300 Chips Bought by Dell45 Copiers Bought by DellDell Produces 1,000 Computers (P = $2,000) – sold to consumersLeaves 300 Chips in inventories
5 Copiers bought by households
GDP Calculation1,500 computer chips @ $100
$150,000
50 copiers @ $5000 $250,000
1,000 computers @ $2,000
$2,000,000
- $355,000Expenses
Equipment Investment $225,000
Inventory Investment $30,000
GDP $2,300,000
Firms Households
Product Markets
Rest of WorldGovernment
Exports Imports
We could go about this a different way…each good or service produced must be matched by an equal expenditure
GDP
GGDP C I G NX
Let’s recalculate using expenditures
Suppose that Intel produces 1,500 computer chips (P = $100)
Suppose that Xerox produces 50 copiers (P = $5000)
200 Chips bought by households
1,300 Chips Bought by Dell45 Copiers Bought by DellDell Produces 1,000 Computers (P = $2,000) – sold to consumersLeaves 300 Chips in inventories
5 Copiers bought by households
GDP CalculationEquipment Investment $225,000
Inventory Investment $30,000
GDP $2,300,000
1,000 Computers @ $2,000
$2,000,000
$20,000
$25,0005 Copiers @$5,000
200 Chips @$100
Category Amount (B) % of Total
Consumption $11,973 68%
Gross Investment $2,890 16%
Government $3,207 18%
Net Exports -$515 -2%
GDP $17,555 100%
GDP: 2014Q3
The GDP report comes out during the last week of every month and gives a breakdown by expenditure category
Problem: What about foreign companies producing in the US or US companies located abroad? What defines an “American Good”?
In 1992, BMW built a production facility in Spartanburg, South Carolina – it employs 10,000 people and produced 297,326 units in 2013 (approx. $13B).
Nike began manufacturing sport shoes and apparel in Thailand in 1980. Currently Nike has 84 contract factories employing 75,000 people and producing $500M annually.
Gross Domestic Product vs. Gross National Product
Current market value of all goods and services produces within the borders of the US, regardless of ownership of the company
Current market value of all goods and services produces by citizens of the US, regardless of location of the company
If its produced in America, its an American good!
If its produced by an American, its an American good!
What defines an “American Good”?
BMW• Sales: $13B• Value Added: $5B
$3B paid to American labor $1B paid to Foreign labor $400M paid to US investors $600M Paid to foreign investors
Nike• Sales: $500M• Value Added: $200M
$50M Paid to Foreign labor $10M paid to American labor $40M paid to foreign investors $100M paid to American investors
GDP $5B
$0
GDP $5B
Nike’s output was produced outside the US
BMW’s output was produced inside the US
Problem: What about foreign companies producing in the US or US companies located abroad? What defines an “American Good”?
BMW• Sales: $13B• Value Added: $5B
$3B paid to American labor $1B paid to Foreign labor $400M paid to US investors $600M Paid to foreign investors
Nike• Sales: $500M• Value Added: $200M
$50M Paid to Foreign labor $10M paid to American labor $40M paid to foreign investors $100M paid to American investors
GNP $3B
$10M
GDP $3.51B
Paid as wages to US citizens
$400M Paid as profits to US investors
Paid as wages to US citizens
Paid as profits to US investors$100M
Alternatively….
BMW• Sales: $13B• Value Added: $5B
$3B paid to American labor $1B paid to Foreign labor $400M paid to US investors $600M Paid to foreign investors
Nike• Sales: $500M• Value Added: $200M
$50M Paid to Foreign labor $10M paid to American labor $40M paid to foreign investors $100M paid to American investors
GDP
$5B
$0
GDP $5B
Nike’s output was produced outside the US
BMW’s output was produced inside the US
+ $10M paid to American labor
$100M paid to American investors +
Income earned by Americans abroad
- $1B paid to Foreign labor
$600M paid to Foreign investors -
Income earned by foreigners in the US
GNP $3.51B
We could begin with GDP and add in Net Factor Payments (Income earned by Americans abroad minus income earned by foreigners in the US)
Firms Households
Factor Markets
GDP
A third way to approach this would be to realize that every dollar of value added will generate an equal dollars worth of income.
National Income
$17,599
+ Net Factor Payments- Depreciation
National Income
GDP$ 213
$14,845
$ 2,967
National Income by Source: 2014Q3
Category Amount(B) % of Total
Wages $9,241 62%
Proprietor’s Income $1,387 9%
Rental Income $647 4%
Income on Assets $2,178 14%
Transfer receipts $2,553 17%
Less Contributions - $1,161 6%
National Income $14,845 100%
Labor Share of Income
Capital Share of Income
Firms Households
Product Markets
Financial Markets
Rest of World
Government
National Income
Note that every dollar that’s earned in the US gets allocated to some purpose
NNI C I G CA
Firms Households
Financial Markets
Rest of WorldGovernment
Foreign Borrowing
Foreign Lending
Lastly, we have an accounting identity for the financial markets known as the flow of funds
NS I G T CA
Note that the accounting identities work together…that is, one identity implies another
GGDP C I G NX NFP NFP
GGNP C I G CA
Output equals expenditures
CA NX NFP
DEP DEPNNI C I G CA
N GI I DEP
Income equals Outlays
Note that the accounting identities work together…that is, one identity implies another
NNI C I G CA T T
NNI T C I G T CA
Income Equals Outlays
C C
NNI T C I G T CA
NI T C S
Flow of Funds
Government Deficit
-900
-800
-700
-600
-500
-400
-300
-200
-100
0
1001960-01-01 1970-01-01 1980-01-01 1990-01-01 2000-01-01 2010-01-01
Billions of D
ollars
Last year, the US current account was -$380B. What does this mean?
In other words, the US is borrowing $1B per day from abroad! Should we be worried about this?
NCA NI C I G Total US Income Total US Spending
We can analyze this using the “Income Equals Outlays” Identity….
Or, we can analyze this using the “Flow of Funds” Identity….
CATGIS N
Domestic Saving
Public Borrowing
Private Borrowing
We are living beyond our means!
We are borrowing more that we are saving!
Lets take a look at the US economy from 1947 to 2008 …
1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 20120
2000
4000
6000
8000
10000
12000
14000
16000
18000
20000
Billi
ons
of D
olla
rs
$243.1B(1947Q1)
$17,044B(2014Q1)
Average Annual Growth
ln 17,044 ln 243.1*100 6.34%
67
However, remember the problem we ran into with the movie grosses. GDP (current market value of goods and services produced) isn’t really the same in 1947 as it is in 2014 because the dollar has lost a lot of its value (i.e. prices have gone up)
1947
Car: $1,500Gasoline: 23 cents/galHouse: $13,000Bread: 12 cents/loafMilk: 80 cents/galPostage Stamp: 3 cents
Car: $30,303Gasoline: 3.48 dollars/galHouse: $215,000Bread: $2.00 dollars/loafMilk: 3.50 dollars/galPostage Stamp: 49 cents
2014
We need to construct a “price index” to represent and average of prices over a wide variety of products. How do we do this?
The objective of a price index is to measure cost of living. To state this precisely, a price index measures the dollar cost of obtaining a fixed level of utility (happiness). Suppose at the current prices, you elect to buy 3 slices of pizza and 2 beers
Example:
$3.50 $2.00
The absolute dollar cost of your current happiness is (2)($3.50) + (3)($2.00) = $13
(2)($4.50) + (3)($2.20) = $15.60 ln 15.60 ln 13 *100 18%
Good Base Year Price (BY)
Base Year Quantity
Current Year Price (CY)
Inflation
Beer $3.50 2 $4.50 25%
Pizza $2 3 $2.20 10%
As prices change, we keep the quantities of each good constant (guaranteeing a constant level of utility)
Good Base Year Price (BY)
Base Year Quantity
Current Year Price (CY)
Inflation
Beer $3.50 2 $4.50 25%
Pizza $2 3 $2.20 10%
Base Year Expenditure: (2)($3.50) + (3)($2.00) = $13
Beer Expenditure Share: (2)($3.50)/$13 =.54Pizza Expenditure Share: (3)($2)/$13 = .46
Alternatively, we could write the price index in terms of relative dollars (relative to a base year) instead of absolute dollars (this is how its actually calculated).
4.50 2.20.54 .46 1.2
3.50 2.00CYP
3.50 2.00.54 .46 1.0
3.50 2.00BYP
(Or, 100)
(Or, 120)
ln 120 ln 100 *100 18%
The CPI is calculated by the Bureau of Labor Statistics (BLS) on a monthly basis
Education & Communication
5%
Tobacco & Smoking Products
1%
Recreation6%
Medical6%
Housing40%
Food & Beverage16%
Apparel5%
Personal Care4%
Transportation17%
The CPI is composed of 211 individual products over 38 geographic areas (8,018 total prices).
Consumer Price Index
When Calculating the Consumer Price Index, the expenditure shares remain constant!!!
Good Base Year Price (1983) Year 2013 Price Year 2014 Price
Housing $200 $780 $800
Transportation $90 $280 $300
Food $40 $190 $200
Apparel $30 $245 $250
Household Budget
2013
780 280 190 245.40 .30 .20 .10 4.25
200 90 40 30CPI
CPI inflation (2013 – 2014)
ln 4.43 ln 4.25 *100 4.15%
Or, 425
2014
800 300 200 250.40 .30 .20 .10 4.43
200 90 40 30CPI
( or, 443 )
Average CPI inflation
ln 443 ln 100*100 4.80%
31
1983
200 90 40 30.40 .30 .20 .10 1
200 90 40 30CPI
( or, 100 )
1948 1958 1968 1978 1988 1998 2008
-4
-2
0
2
4
6
8
10
12
14
16
0
50
100
150
200
250
1983 = 100
CP
I
CP
I In
flatio
n R
ate
CPI
The Consumer Price Index (1948 – 2014)
Average Inflation = 3.54%
Note That expenditure shares do change over time, so the weights need to be updated periodically
Potential problem #1: Products change over time. Suppose you observe the following TV Prices
Price: $250Features: 27 inch
Cathode Ray TubeEnhanced Definition TVS-Video InputUniversal Remote
Price: $1,250Features: 42 inch
PlasmaHigh Definition TVS-Video InputUniversal Remote
$1,250 $250*100 400%
$250
2003
Note: The first plasma TV was released by Fijitsu 1n 1995. The 42’’ TV cost $14,999
2004
Is this a fair assessment of inflation?
Solution: Hedonic Price Adjusting
Price: $250Features: 27 inch
Cathode Ray TubeEnhanced Definition TVS-Video InputUniversal Remote
Price: $1,250Features: 42 inch
PlasmaHigh Definition TVS-Video InputUniversal Remote These three featured
are estimated to be worth $1000
These three featured are estimated to be worth $100
Hedonically Adjusted price = $1,250 – ($1,000 -$100) = $350
Potential Problem #2: What about housing? Consider the following examples
Option #1: Rent a $240,000 house
Option #2: Buy a $240,000 house with an interest only mortgage (5% per year)
Option #3: Buy a $240,000 house with a 30 year mortgage (5% per year)
$240,000(.05) = $12,000/yr. = $1,000/mo.
$1,288/mo.$1,000/mo.
One of these things is not like the other!
Potential Problem #2: What about housing? Consider the following examples
Option #1: Rent a $240,000 house
Option #2: Buy a $240,000 house with an interest only mortgage (5% per year)
Option #3: Buy a $240,000 house with a 30 year mortgage (5% per year)
$1,288/mo.
$1,000/mo.
Difference = $288/mo.
OR
What if you put $288/mo. and put it in a savings account that earns 5% per year?
$240,000
Potential Problem #2: What about housing? Consider the following examples
Option #1: Rent a $240,000 house
Option #2: Buy a $240,000 house with an interest only mortgage (5% per year)
$1,000/mo.OR
(This is pure cost of living)
Option #3: Buy a $240,000 house with a 30 year mortgage (5% per year)
$1,288/mo.
(This is cost of living plus investment in an asset)
Solution: In 1983, the BLS decided to focus entirely on rental markets for housing.
1976 1981 1986 1991 1996 2001 2006 20110.0
50.0
100.0
150.0
200.0
250.0
300.0
350.0
400.0
Home Price Index Rental Price Index
Housing Prices
1976 1981 1986 1991 1996 2001 2006 2011
-10
-5
0
5
10
15
20
Home Price Rental Price
Housing Inflation
Average Inflation Rate
Home Price Index: 4.40%Rental Index: 4.01%
Can you spot the housing bubble?
Potential Problem #3: Substitution
$3.50 $2.00
Recall that at the original prices, you elected to buy 3 slices of pizza and 2 beers
The cost of your happiness was (2)($3.50) + (3)($2.00) = $13
If beer increases in price to $4.50 (25% increase) and pizza increases to $2.20 (10% increase), suppose you alter your decision and buy 1 beer and 4 slices of pizza
(1)($4.50) + (4)($2.20) = $13.30
ln 13.30 ln 13 *100 2.2%
Good Base Year Price (BY)
Current Year Price (CY)
Inflation
Beer $3.50 $4.50 25%
Pizza $2 $2.20 10%
Good Base Year Price (BY)
Current Year Price (CY)
Inflation
Beer $3.50 $4.50 25%
Pizza $2 $2.20 10%
No Substitution:
Original Expenditure:
(2)($3.50) + (3)($2.00) = $13
(1)($4.50) + (4)($2.20) = $13.30
ln 13.30 ln 13 *100 2.2%
Substitution:
(2)($4.50) + (3)($2.20) = $15.60
Which measure of inflation is more realistic?
ln 15.60 ln 13 *100 18%
Solution: In 2000, the BLS introduced a “chain weighted CPI” that allows for this substitution between different goods. It’s thought to be a better gauge of inflation
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
0.000
20.000
40.000
60.000
80.000
100.000
120.000
140.000
160.000
CCPI
Infla
tion
Rat
e
Chained C
PI
It is, however, very controversial…
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
-3
-2
-1
0
1
2
3
4
5
6
CPI CCPI
Infla
tion
Rat
e
Average Inflation Rate
CPI: 2.31%CCPI: 2.06%
CPI Inflation Rate (2.31% per year)
CCPI Inflation Rate (2.06% Per Year)
Example: Suppose that you are a social security recipient. Let’s calculate your total payments received in social security payments under the different inflation measures from 2000 to 2014. (Assume you received $1,000 per month in 2000)
2 14$12,000 $12,000 1.0231 $12,000 1.0231 ... $12, 000 1.0231 $212,232
2 14$12,000 $12,000 1.0206 $12,000 1.0206 ... $12, 000 1.0206 $208,442
Difference = $3,790 ($270/yr.)
Now, consider that there are approximately 65 million social security recipients:
$3,790*65M = $246B ($18B/yr.)
An alternative to the consumer price index is the GDP Deflator.
Good Production (2014) Current Price (2014) Current Value
Housing 300 $550 $165,000
Transportation 500 $350 $175,000
Food 100 $260 $26,000
Apparel 200 $220 $44,000
Total = GDP (Current Dollars) $410,000
Suppose we have the following Data
Now, Suppose we revalue current GDP at, say, prices in 2009 (Call this the base year)
Good Production (2014) 2009 Price 2009 Value
Housing 300 $500 $150,000
Transportation 500 $300 $150,000
Food 100 $200 $20,000
Apparel 200 $200 $40,000
Total = GDP (2009 Dollars) $360,000
Current value of current production (2014)
$410,000 (Current Dollars)
Base year value of current production (Base year = 2009)
$360,000 (2009 Dollars)
We can use these two numbers to construct an implied relative price
$410,000 (Current Dollars)
$360,000 (2009 Dollars)= 1.14 (or, 114)
Note that the base year (2009) is 1 (or, 100) by definition
ln 114 ln 100*100 2.62%
5
Note that the price index is still a weighted average of individual relative prices
Good Production (2014) 2009 Price 2009 Value 2014 Price
Housing 300 $500 $150,000 $550
Transportation 500 $300 $150,000 $350
Food 100 $200 $20,000 $260
Apparel 200 $200 $40,000 $220
Total = GDP (2009 Prices) $360,000
$150,000.41
$360,000
Housing Share of Real GDP
$150,000.41
$360,000
Transp. Share of Real GDP
$20,000.06
$360,000
Food Share of Real GDP
$40,000.12
$360,000
Apparel Share of Real GDP
$550 $350 $260 $220.41 .41 .06 .12 1.14
$500 $300 $200 $200P
(Or, 114)
With the implied weights, you can calculate the GDP deflator in a similar fashion as the CPI
Good Production (2013) 2009 Price 2013 Price
Housing 280 $500 $535
Transportation 490 $300 $310
Food 105 $200 $240
Apparel 170 $200 $216
$363,620
$342,000= 1.06 (or, 106)
Suppose we repeat for a different year to calculate an inflation rate
$140,000.41
$342,000
Housing Share of Real GDP
$147,000.43
$342,000
Transp. Share of Real GDP
$21,000.06
$342,000
Food Share of Real GDP
$34,000.10
$342,000
Apparel Share of Real GDP
$535 $310 $240 $216.41 .41 .06 .12 1.06
$500 $300 $200 $200P
(Or, 106)
ln 114 ln 106 *100 7.27% Index Inflation
Value of GDP at 2013 Prices
Value of GDP at 2009 Prices
Good 2013 Price 2014 Price Inflation
Housing $535 $550 2.76%
Transportation $310 $350 12.10%
Food $240 $260 8.00%
Apparel $216 $220 1.83%
Now, the inflation rate incorporates price changes as well as expenditure share changes – a lot like the chained CPI!
$140,000.41
$342,000
Housing Share of Real GDP
$147,000.43
$342,000
Transp. Share of Real GDP
$21,000.06
$342,000
Food Share of Real GDP
$34,000.10
$342,000
Apparel Share of Real GDP
2013
2014
$150,000.41
$360,000
Housing Share of Real GDP
$150,000.41
$360,000
Transp. Share of Real GDP
$20,000.06
$360,000
Food Share of Real GDP
$40,000.12
$360,000
Apparel Share of Real GDP
1948 1958 1968 1978 1988 1998 2008
-4
-2
0
2
4
6
8
10
12
0
20
40
60
80
100
120
Average Inflation: 3.20%
GDP Def.G
DP
Deflator
2009 = 100
The GDP Deflator: 1948 - 2014
Infla
tion
Rat
e
Inflation with the GDP Deflator versus the CPI
1948-01-01 1958-01-01 1968-01-01 1978-01-01 1988-01-01 1998-01-01 2008-01-01
-4
-2
0
2
4
6
8
10
12
14
16
CPI GDP Deflator
Average Inflation
CPI: 3.55%GDP Def.: 3.20%
Let’s enlarge this area
2001 2003 2005 2007 2009 2011 2013
-2
-1
0
1
2
3
4
5
6
CPI GDP DEF
What’s going on here?
Average Inflation
CPI: 2.30%GDP Deflator: 2.01%
Inflation with the GDP Deflator versus the CPI
2001 2003 2005 2007 2009 2011 2013
-2
-1
0
1
2
3
4
5
6
CPI GDP DEF
2001 2003 2005 2007 2009 2011 2013
-100
-80
-60
-40
-20
0
20
40
60
80
Oil Price Inflation
Recall that a large portion of our oil is imported and is therefore not a part of GDP. Which means its not a part of the GDP deflator!
The “core CPI” removes food and energy prices due to their excessive volatility.
Average Inflation
CPI: 2.30%Chain CPI: 2.06%GDP Deflator: 2.01%Core CPI: 1.95%
Lets get back to the US economy from 1947 to 2008 …
1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 20120
2000
4000
6000
8000
10000
12000
14000
16000
18000
20000
Billi
ons
of D
olla
rs
$243.1B(1947Q1)
$17,044B(2014Q1)
Average Annual Growth
ln 17,044 ln 243.1*100 6.34%
67
Lets use the consumer price index to adjust these nominal values to reflect year 2000 prices
1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 20120
2000
4000
6000
8000
10000
12000
14000
16000
18000
20000
Billi
ons
of D
olla
rs
$17,044B2014Q1
Average Annual Real Growth
ln 12,129 ln 1,938*100 2.73%
67
$243.1B(1947Q1)
173$243.1 $1,938
21.7B B
173$17,044 $12,129
243.1B B
1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 20120
2000
4000
6000
8000
10000
12000
14000Bi
llion
s of
200
0 D
olla
rs
$12,129B2014Q1
$1,938B(1947Q1)
Now, looking at real GDP over the last 67 years, we should see two basic features in the data
1) The US economy grows over time
2) The US doesn’t grow at a constant rate
GDP
Time
Trend (Average growth)
“Business Cycle” (deviations from average growth)
Here’s an exaggerated view of what we are talking about
GDP
Time
Trend (Average growth)
The business cycle is a repeated pattern of recessions followed by recoveries
Recession (Below Trend Growth)
Recovery (Above Trend Growth)
Peak
Trough
Peak
1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 20120
2000
4000
6000
8000
10000
12000
14000
Billi
ons
of 2
000
Dol
lars
How can we best describe long run growth in the US? A linear trend describes growth as Dollars per year
1042 41.5GDP x
1,042
X=0 (Quarters)1947Q1
X=180 (Quarters)1992Q1
1042 41.5 180 8,512GDP
8,512
Quarterly Inflation Adjusted Dollar Growth
1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 20120
2000
4000
6000
8000
10000
12000
14000Bi
llion
s of
200
0 D
olla
rs
How can we best describe long run growth in the US?An exponential trend describes growth as Dollars per year
.0072246 xGDP e
Quarterly Inflation Adjusted percentage growth
X=0 (Quarters)1947Q1
2,246
X=160 (Quarters)1987Q1
.007 1602246 6,883GDP e
6,883
Annu
al G
row
th R
ate
1950's 1960's 1970's 1980's 1990's 2000's1
2
3
4
5
Average Real Growth = 3%
Current Real Growth
An exponential trend assumes that the US has some constant annual rate of real economic growth (~3% per year). Note that actual growth varies even over long time periods.
0
1
2
3
4
5
6
Annu
al G
row
th R
ate
Actually, it looks like long term growth in the US actually has its own cycle...again, an exponential trend can’t capture this
1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 20120
2000
4000
6000
8000
10000
12000
14000Bi
llion
s of
200
0 D
olla
rs
$12,129B2014Q1
$1,938B(1947Q1)
The HP trend allows trend growth to vary over time
The HP Trend solves this minimization problem
Here we have annualized growth rates of the HP trend and the Exponential trend
0
1
2
3
4
5
6
1957 1962 1967 1972 1977 1982 1987 1992 1997 2002
Exponential Trend Growth HP Trend Growth
Once we have identified the trend, we can subtract it out to leave the cycle component all by itself.
GDP
Time
Trend (Average growth)
Actual GDP
Trend GDP
*100Actual Trend
DeviationTrend
1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 20120
2000
4000
6000
8000
10000
12000
14000Bi
llion
s of
200
0 D
olla
rs
.0072246 xGDP e
Quarterly Inflation Adjusted percentage growth
X=0 (Quarters)1947Q1
2,246
X=160 (Quarters)1987Q1
.007 1602246 6,883GDP e
6,883
7,328Actual
7,3286,883
7,328 6,883*100 6.5%
6,883Deviation
6.5%
We end up with a series that looks like this
% Deviation From Trend
Time
0
Trough
Peak Peak
Recession Recovery
1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012
-8
-6
-4
-2
0
2
4
6
Perc
enta
ge D
evia
tion
from
HP
Tren
d
Let’s look at the cycle component for the US
The US has had 11 Cycles since the World War II
1 2 3 4 5 6 7 8 9 10 11
Business Cycle Dates Duration (In Months)
Peak Trough Contraction (peak to trough)
Expansion (Previous trough to this peak)
Cycle (Peak from previous peak)
Nov 1948 Oct 1949 11 37 45
July 1953 May 1954 10 45 56
Aug 1957 April 1958 8 39 49
April 1960 Feb 1961 10 24 32
Dec 1969 Nov 1970 11 106 116
Nov 1973 March 1975 16 36 47
Jan 1980 July 1980 6 58 74
July 1981 Nov 1982 16 12 18
July 1990 March 1991 8 92 108
March 2001 Nov 2001 8 120 128
December 2007 June 2009 18 73 81
Average 13 55 68
The US has had 11 Cycles since the World War II
When we talk about “business cycle frequency, we are referring to cycles between 2 and 8 yrs.
Average (Months) Recession (Peak to Trough)
Expansion (Trough to peak)
Cycle ( Peak to Peak)
1854 – 2009 (33 cycles) 17.5 38.7 56.2
1854 – 1919 (16 cycles) 21.6 26.6 48.2
1919 – 1945 (6 cycles) 18.2 35.0 53.2
1945 – 2009 (11 cycles) 11.1 58.4 69.5
When we talk about “business cycle frequency, we are referring to cycles between 2 and 8 yrs.
The US has had 33 Cycles since the Civil War. On averages, in recent years, the recessions are getting shorter and the recoveries longer
1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007 2012
-8
-6
-4
-2
0
2
4
6Pe
rcen
tage
Dev
iatio
n fr
om T
rend
It also seems that recently, the business cycle has become less severe in recent years.
1 2 3 4 5 6 7 8 9 10 11
1/1/1919 1/1/1939 1/1/1959 1/1/1979 1/1/1999
-40
-30
-20
-10
0
10
20
30
Great Depression WWII
In fact, look at the cycle now relative to the great depression era%
Dev
iatio
n fr
om tr
end
Indu
stria
l Pro
ducti
on
2007-01-01 2009-01-01 2011-01-01 2013-01-0112500
13000
13500
14000
14500
15000
15500
16000
16500
Nominal GDP Real GDP (2005 $s)
$13,326B
$14,253B$13,952B
$12,746B
$16,101B
$13,750B
Nominal GDP: -2%Real GDP: -4.5%Price: 2.5%
Nominal GDP: 15%Real GDP: 7.5%Price: 7.5%
Lets look at the last few years
2006-07-01 2008-07-01 2010-07-01 2012-07-01
-10
-8
-6
-4
-2
0
2
4
6
Average (Since 2000): 1.7%Average (Since 1947): 2.7%
1.7%
Recession Recovery
Growth rate below long run average Growth rate above long run average
2.7%
2007-01-01 2009-01-01 2011-01-01 2013-01-0112500.0
12700.0
12900.0
13100.0
13300.0
13500.0
13700.0
13900.0
Real GDP Trend Real GDP
% Deviation from Trend (Cycle)
GD
P
$13,326B
$12,994B
13,326 12,994*100 2.5%
12,994
% Deviation from Trend (Cycle)
$13,118B
$12,746B
Trend
12,746 13,118*100 2.8%
13,118
Actual
2007-01-01 2009-01-01 2011-01-01 2013-01-01
-4
-3
-2
-1
0
1
2
3
Recession Recovery
% D
evia
tion
from
tren
d G
DP
Dec. 2007“Peak”
June 2009“Trough”
2.5%
-2.8%
Top Related