Macroeconomics and Forecasting: What, Me Worry?

1. EC 827 Section A: Module I Introduction: Economic Concepts, Measurements and Data Sources

2. Vital Statistics • Geoff Jenkins • Campus Address: Department of Economics 108 Old Botany Hall Michigan State University East Lansing, MI 48824-1038 (517) 355-1861 • e-mail: jenkinsg@pilot.msu.edu • Office Hours: Business Complex ?

3. Organizational Information • EC 827- Economics Web Page • use Netscape or Internet Explorer to open: • http://www.msu.edu/course/ec/827/ • Email contact • jenkinsg@pilot.msu.edu

4. Organizational Information • Resources available on EC 827 homepage: • Electronic Syllabus • Assorted “how to” guides, etc. • PowerPoint presentations

5. Organizational Information • Working Assumptions • Skilled at Using e-mail • Skilled at basic functions of Netscape/IE, Word, Excel (including formula) and PowerPoint • Course Structure • Split between Section A and Section B • Section A: forecasting models • Section B: macroeconomics

6. Macroeconomics and Forecasting: What, Me Worry? • Conditional Business Strategies • Macroeconomic Environment (National and International) as a Conditioning Factor

7. Macroeconomic Impacts- Examples I • Southeast Asia 1997-8-9, Russia 1998-9 • US Auto Industry in 70s and 80s • (import competition) • Japanese Auto Industry in Early 90s • (yen appreciation) • S&L Industry & Inflation in late 70s • Texas vs. World Oil Prices: 1986

8. Part I Economic Activity, Growth, Inflation, Unemployment, and Policy Trade-offs

9. Measuring Economic Activity: GDP • Gross Domestic Product (GDP) • Measure of the amount of all currently produced goods and services that are sold on markets but not resold during the period of measurement. • Measure of Production • Transactions that involve existing assets are excluded - production (and GDP ) of past. • Non-market activity (including productive activity within household) generally not included

10. Measuring Economic Activity: GDP • GDP as a flow • measured over some period of time; without reference to the time period, the concept has no meaning • U.S. and most major countries measure over quarterly and annual periods • SAAR (seasonally adjusted at annual rates), i.e. corrected for normal seasonal fluctuations, and then extrapolated to a year ahead.

11. Measuring Economic Activity: GDP • Seasonal Adjustment - Statistical Technique to smooth out regular intra-year fluctuations • reduces value in fourth quarter and increases value in other three quarters • particular importance in certain sectors, e.g. consumer goods, agriculture • Annual Rates - adjustment to indicate rate of production if continued at current pace for a full year.

12. Measuring Economic Activity: GDP • If there’s inflation, nominal (current dollar) GDP overstates rate at which economy is growing. • The Dollar value of the economy can grow, simply because prices rise, not because of increased output of real goods & services. • Real GDP is a quantity measure - most comprehensive measure of volume of production - independent of price changes

13. Measuring Economic Activity: GDP • Real and Nominal GDP • Measuring aggregate of non-homogeneous items requires a common unit of measurement • Nominal GDP (current dollar) measures value of current production in the monetary unit of the country • Real GDP (constant dollar) measures amount of production valued at the prices of some specific point in time (base year)

14. Measuring Economic Activity: GDP • Real and Nominal GDP, cont. • By construction, real and nominal GDP are same in base year • Base year in U.S. data updated approximately every five years. • Feb, 1996 was last update to base year of 1992 from 1987. • Purpose of updating base year is to minimize measurement errors in most recent real GDP data

15. Historical Perspective-Nominal and Real GDP Nominal and Real GDP 8000 Nominal GDP 7000 Real GDP 6000 5000 4000 3000 2000 1000 0 1875 1889 1903 1917 1931 1945 1959 1973 1987 Year

16. 20 15 10 5 0 -5 -10 -15 -20 -25 1876 1889 1902 1915 1928 1941 1954 1967 1980 1993 Year Historical Perspective -Real Growth Real Growth Rate

17. Measuring Economic Activity:Alternatives • Industrial Production • manufacturing sector • Personal Income • income received before personal taxes • If all that you’re measuring is economic activity, income should equal production or expenditure: what you make determines what you earn determines what you spend.

18. Business Cycle Phases • Recession (falling GDP) • Recovery (rising GDP, out of the trough) • Expansion (to above average levels of GDP) • Average U.S. Cycle Duration 48 Months • Recession - 18 months average • Recovery and Expansion - 30 months average

19. Trough Months October, 1949 May, 1954 April, 1958 February, 1961 November, 1970 March, 1975 July, 1980 November, 1982 March, 1991 Peak Months November, 1948 July, 1953 August, 1957 April, 1960 December, 1969 November, 1973 January, 1980 July, 1981 July, 1990 U.S. Business Cycles: 1948-

20. Average Real GDP Growth During Recessions • 48-9: -1.1 % annual rate • 53-4: -2.2 % annual rate • 57-8: -3.4 % annual rate • 60-1: -0.1 % annual rate • 69-70: 0.2 % annual rate • 73-5: -2.3 % annual rate • 80-1: -4.9 % annual rate • 81-2: -1.7 % annual rate • 90-1: -3.4 % annual rate

21. Average Real GDP Growth During Expansions • 49-53: 7.5 % annual rate • 54-57: 3.4 % annual rate • 58-60: 4.7 % annual rate • 61-69: 4.2 % annual rate • 70-73: 4.4 % annual rate • 75-80: 3.8 % annual rate • 80-81: 3.2 % annual rate • 82-90: 3.3 % annual rate

22. Inflation: Consumer Price Index • Consumer Price Index - CPI • Measures average price of goods and services purchased by urban, wage earning families. • Prices measured relative to base year prices. Current base period = 1982-84 • Data collected monthly • Used to index many contracts, both private and government (e.g. Social Security)

23. Inflation: Consumer Price Index • Measurement Biases in CPI • New Products • Quality Improvements/Adjustments • Discount Stores = sample selection problem. • Measurement Problems generally believed to add upward bias to CPI inflation of 0.5 to 1.0 percent per year • Political issues of re-calibration… how to fix the deficit and enrage the AARP in one easy step...

24. CPI Inflation Rate 18 12 6 0 -6 -12 1876 1889 1902 1915 1928 1941 1954 1967 1980 1993 Year Historical Perspective -CPI Inflation

25. Inflation: Post WWII Experience • Stability: 1950s - 64 • War: Vietnam Era: 1965-73 • Sudden, unpleasant surprises: Oil: 1974-81 • “Volcker Disinflation”: 1981-2 • Stability: 1980s, • “Greenspan period”: 1987-present

26. Employment and Unemployment • Consumer (Household) Survey Data • Employed if working • ignores underemployed or overemployed • In Labor Force if Employed or looking for work. • Homemaking? Only if you’re a French politician… • Unemployed = Labor Force - Employed • Unemployment Rate = Unemployed/Labor Force

27. UnemploymentRate 1890-1995 30 25 20 Percent 15 10 5 0 1890 1902 1914 1926 1938 1950 1962 1974 1986 Year Historical Perspective -Unemployment Rate

28. Unemployment Rate • Frictional Unemployment • The lucky: Moving from job to job • Natural Rate of Unemployment • Cyclical Unemployment • The unlucky: Waiting for better days • Structural Unemployment • The clueless, helpless, hapless, hopeless • These are the people that need & can use help

29. Historical Perspective - Inflation vs Unemployment Phillips Curve 1890-1995 25 20 15 10 Inflation Rate 5 0 -5 -10 -15 0 5 10 15 20 25 30 Unemployment Rate

30. Part V Interest Rates

31. Interest Rates • Nominal Interest rates • measure the fraction (or percentage) of value of a loan earned by lender (or paid by borrower) per time period • Short-term nominal rates • Long-term nominal rates • Term Structure of Interest Rates

32. Historical Perspective - Nominal Interest Rates Long- and Short-term Nominal Interest Rates 16 COM_PAPER CORP_BOND 14 12 10 Percent 8 6 4 2 0 1875 1888 1901 1914 1927 1940 1953 1966 1979 1992 Year

33. Interest Rates • Real Interest rates • measure the fraction (or percentage) of the purchasing power of a loan that lenders expect to earn (or borrowers expect to pay) per period • requires a measure of expectations (or forecasts) of inflation over the life of the loan • real rate approximately equal to nominal rate - expected future rate of inflation • Fisher-effect problems

34. Part II How to get Economic Data

35. FRED • No Central Statistical Agency in U.S. • Federal Reserve Bank of St. Louis • maintains an electronic data base • accessible via Internet • Web address: • http://www.stls.frb.org/fred • data series can be downloaded using Netscape to local computer files • see How To on EC 827 Web page

36. Using Data Retrieved from FRED • Data files can be opened and analyzed with Excel • eliminating blank rows: see How to on EC 827 home page • Creating quarterly dates: see How to on EC 827 home page • Creating quarterly average data from monthly series: see How to on EC 827 home page

37. US Economic DataGraphs • National Economic Trends • Federal Reserve Bank of St. Louis • www.stls.frb.org/publ/net • Monetary Trends • Federal Reserve Bank of St. Louis • www.stls.frb.org/publ/mt

38. www.stls.frb.org/publ/netExample

39. Weekly US Financial DataGraphs • Federal Reserve Bank of St. Louis • US Financial Data • www.stls.frb.org/publ/usfd • Most US Economic data is either unavailable or unreliable over short (weekly, daily) periods, but the same techniques can be applied as for longer term data

40. www.stls.frb.org/publ/usfdExample