FIN 30220: Macroeconomic Analysis

1. FIN 30220: Macroeconomic Analysis Using Economic Data

2. “There are three kinds of lies; Lies, Damn Lies, and Statistics” - Mark Twain

3. Principle #1: What are you trying to measure? How is your statistic defined ? Is your statistic consistent with what you are trying to measure? Example: Poverty in the US

4. Lets see how we compare to other parts of the world… Austria: 6% Russia: 16% England: 14% Canada: 11% US: 12% Brazil: 31% China: 8% Mexico: 14% Iran: 18% Chad: 80% Bolivia: 60% Zimbabwe: 68% Argentina: 24% Australia: 10% But, How would you define poverty? Source: CIA Factbook

5. Poverty was defined by Mollie Orshansky of the SSA in 1964 as 3 times the cost of the Dept. of Agriculture’s “Low cost food plan” That number has been indexed by inflation every year (The Johnson Administration later substituted the “economy” food plan)

6. USDA Food Plans: 1964 (Poverty Line in 1964) (Approximate Poverty Line Today) Average Annual Inflation Rate

7. Food Budget as a percentage of household income: 1964 Lower Income Households spent around 33% on Food in 1964

8. The Average Family Budget: 2003 The Average Family Spends Nowhere near 33% on Food Today!!

9. Food Budget as a percentage of household income: 2003 In Fact, No Family Spends Anything Near 33% on Food Today!!!

10. Suppose we use current food prices and the current budget share (Poverty Line in 2014?) Assuming Food is 16.5% of ones budget

11. Actual Calculation So, which is it and why should we care? 15% Difference Redefined Household Budget (Current food prices)

12. A more important question: Is it “absolute” income that we really care about? The Simpsons have a household income of $35,000. Median income is Springfield is $50,000 The Griffins have a household income of $45,000. Median income is Quahog is $85,000 Which of these two families do you think is happier?

13. Relative poverty measures define poverty as a certain percentage of median household income Poverty Line for 3.5 Person Household= $20,000 (40% of Median) Median Household Income = $50,000

14. Altering the definition of poverty can make a big difference when comparing across countries!! It also makes a big difference when looking across time periods!

15. International Poverty • Of the 184 member countries of the world bank. 52 countries are considered “high income” – per capita income of more than $9,206/yr. • 66 countries are considered “low income” (less than $746/yr.) • Currently the international poverty standard is $1.08/day!!

16. Principle #2: How is your variable measured? Example: U.S. Unemployment 2007 Recession 2001 Recession 1991 Recession

17. Each month, the Department of Labor surveys 60,000 households. Each household is asked a series of questions: 1) “Are you currently working?” (Note: no mention of part time or full time) YES You are employed (145.8 Million) No 2) “Have you looked for a job in the past 30 days?” YES You are unemployed (9.8 Million) No Unemployment Rate (UR) Unemployed = Labor Force You are not in the labor force (92 Million) 9.8 = = .063 (6.3%) 145.8+ 9.8

18. Over the same month, the Department of Labor surveys 400,000 businesses and asks one question. 1) “How many employees are currently on your payroll?” Total Non-Farm Payrolls (138.4 Million) Wait a minute, that’s not what the household survey reported??? Which is it ??? 1) “Are you currently working?” (Note: no mention of part time or full time) YES You are employed (145.8 Million)

19. The two surveys track each other reasonably well, but there are noticeable differences.

20. However, the establishment survey is subject to fairly large revisions

21. The Establishment Survey Will often times “Double Count” Jobs Suppose you quit your job at company A and find a new job at company B – if this is done in the same payroll period (most payrolls are bi-weekly) you will be counted twice!! No Turnover Turnover Pay Period Pay Period Job at Company A Job at Company B count = 1 payroll job count = 2 payroll jobs In months with high job turnover, the establishment survey will overstate employment.

22. Average US Labor Market Turnover 8.11M jobs are gainedper quarter 7.71M jobs arelostper quarter FYI: Worst-case estimates predict outsourcing costs us 55,000 jobs per quarter.

23. Household Survey vs. Establishment Survey The household survey includes agricultural workers, self employed workers and private household workers. The establishment survey does not. The household survey counts people on unpaid leave as employed – the establishment survey does not. The household survey only counts people over the age of 16 – the establishment survey is not limited by age.

24. Main problems with measuring the unemployment rate • The unemployment rate doesn’t count underemployment(those that would like to work full time, but only work part time) • The “discouraged worker effect”: Those that have given up trying to find a job are counted as not in the labor force rather than unemployed • Selection bias: those that are unemployed are more likely to answer the survey. • Moral hazard: due to unemployment insurance, it is difficult to tell how hard individuals are trying to find work

25. Principle #3:Is your variable in terms of current prices or fixed prices (Real vs. Nominal) Example: The Top 10 All Time Grossing Films (in Millions – US) • Avatar (2009): $760 • Titanic(1997): $658 • Marvel’s the Avengers (2012): $588 • The Dark Knight (2008): $533 • Star Wars I: The Phantom Menace (1999) $474 • Star Wars IV: A New Hope (1977): $460 • The Dark Knight Rises (2012) $449 • Shrek 2 (2011): $441 • E.T. The Extra-Terrestrial (1982): $435 • Pirates of the Caribbean: Dead Man’s Chest (2006): $423

26. Real vs. Nominal Variables Nominal Variables are in terms of a current dollars. For example, you’re starting salary after college might be $50,000 per year. Real variables are in terms of some fixed commodity. Real variables measure purchasing power. If a gallon of gas costs $2.00, then we can calculate your “real” income. Nominal Income $50,000 Real Income = = 25,000 = Price $2.00

27. In 2009, a gallon of gas cost $3.50 Nominal Gross $749M Real Gross = = = 214M Price $3.50 (Gallons of Gas) In 1977, a gallon of gas cost $.62 Nominal Gross $460M Real Income = = 742M = Price $.62 (Gallons of Gas)

28. Usually, the “commodity” used for real variables is a particular year’s dollars. Suppose we want both grosses to reflect 1997 gas prices. (Gas was $1.26 in 1997) Target year Price Real X = Nominal X Current Year Price Target Year $1.26 $1.26 Real Gross Real Gross = $460M = $749M $.62 $3.50 Current Year = $935M = $270M ( 1997 Dollars) ( 1997 Dollars) These two dollar figures are comparable because they represent the same year’s dollars!

29. The Top 10 All Time Grossing Films– Inflation Adjusted (Millions of 2000 Dollars) • Gone With the Wind (1939): $1,689 • Star Wars Episode IV(1977): $960 • The Sound of Music(1965): $768 • ET: The Extraterrestrial(1982): $764 • The Ten Commandments (1956): $706 • Titanic (1997): $691 • Jaws (1975): $690 • Dr. Zhivago (1965): $669 • The Exorcist (1973): $596 • Snow White (1937): $587 Notes: Avatar falls to #14 ($516), a movie ticket in 1939 was $0.23

30. Principle #4: Annualizing Example: Treasury Yields Suppose that you buy a $1,000, 90 Day Treasury Bill for $994 Alternatively, you could buy a $1,000, 5 year bond for $902 90 Days from now, you receive $1,000 from the government 5 years from now, you receive $1,000 from the government $1,000 - $994 $1,000 - $902 X 100 = .6% X 100 =10.86% $994 $902 Which of these two assets is paying a higher return?

31. Suppose that you could earn .6% interest every quarter (90 days). How much would you have in a year? $1 $1.006 $1.012 $1.018 $1.024 2 3 4 $1(1.006) $1(1.006) $1(1.006) $1(1.006) You earned 2.4% (Annualized) For the 5 year bond, we do the same process in reverse (how much would you have to earn per year to get a 10.86% return after 5 years)? $1 $?? $?? $?? $?? $1.1086 2 3 4 5 $1(1+i) $1(1+i) $1(1+i) $1(1+i) $1(1+i) You earned 2.0% (Annualized)

32. Principle #5: What frequency are you interested in? Example: Tax Cuts, Tax Revenues and “VooDoo Economics” The Bush Tax Cuts of 2001 & 2003 lowered marginal tax rates across the board, lowered the capital gains tax, eliminated the estate tax, and lowered the “marriage penalty The tax cut was advertised as “the largest tax cut in history”

33. What do we mean by the “cost” of a tax cut, anyways? Suppose that the Griffin family has a household income of $50,000. Currently, the income tax rate is 20% of all income earned Under the current tax code, the Griffins pay $10,000 per year in Taxes. The cost of the tax cut is the $5,000 in lost revenues If the government cuts the tax rate to 10%, then the Griffin’s tax bill falls to $5,000 By this measure, the Bush Tax cuts have a price tag of around $130 Billion per year!!

34. Let’s take a look at previous marginal tax rate changes to put the Bush tax cut in a historical context. Wilson 1917 Coolidge 1925 FDR 1933 Kennedy 1964 Reagan 1981 Bush 2001/2003 Source: Congressional Budget Office

35. Given an income distribution in 1964, 1981, and 2001/2003, we can estimate the per year “cost” of the three major tax cuts What’s the problem with comparing these numbers?

36. When expressed in real terms as a percentage of GDP, the Bush tax cuts aren’t so big after all! Kennedy 1964 Cost (in 1964 dollars): $11.5B CPI: 30.9 Real GDP: $2998.6B 175.1 $11.5B = $67.6B (2.25% of GDP) 30.9 Reagan 1981 Cost (in 1981 dollars): $38.3B CPI: 87.0 Real GDP: $5,291.7B 175.1 $38.3B = $79.9B (1.5% of GDP) 87.0 Bush 2001/2003 Cost (in 2003 dollars): $134.6B CPI: 175.1 Real GDP: $10,301B 175.1 $134.6B =$134.65B (1.3% of GDP) 175.1

37. Let’s return to the Griffin family. The Griffin family has a household income of $50,000. Currently, the income tax rate is 20%. Under the current tax code, the Johnsons pay $10,000 per year in Taxes. The drop in the tax rate caused revenues to increase rather than decrease! Suppose that a drop in the marginal rate encourages Lois Griffin to go back to work. With the two income earners, the Griffin family income rises to $120,000. At the 10% rate, their tax rises to $12,000 Could this happen?

38. Tax Revenues = (Tax Rate) (Tax Base) The basic logic behind the Laffer Curve is that the tax base should be negatively related to the tax rate. Tax Revenues Is there evidence of a Laffer curve in practice? Tax Rate 0% Revenue Maximizing Rate 100%

39. Tax Revenues History suggests that taxes are two high, but be careful… Tax Rate 0% Revenue Maximizing Rate 100% Source: Congressional Budget Office

40. Once we account for price changes, the Laffer curve effect starts to disappear

41. After correcting for price changes, it appears that empirical evidence suggests the presence of a Laffer curve. However, we need to be careful. Tax cuts generally take place during recessions. Tax revenues are below “normal” during recessions • Economic data can be can be broken into four components: • Trend (many years) • Business Cycle (1-5 years) • Seasonal (Months) • Noise (very short term)

42. Suppose that we were to plot GDP over time. It would look something like this. What do you see? Recessions are periods of below trend growth Expansions are periods of above trend growth GDP Trend growth of real GDP is around 3% per year Time This trend/cycle in GDP appears in all macro data

43. The Laffer effect of a tax cut should affect the trend, but not the cycle… New Tax Code GDP Old Tax Code This is what we have measured This is what we should be measuring Time In other words, we have overstated the Laffer effect in the previous slides