Using the Iowa Electronic Markets in
Macroeconomics
Macroeconomic Conditions: Measurement,
Meaning, and Political Implications
Developed by:
Scott Simkins - North Carolina A&T State University
Tom Gruca - University of Iowa
Eric Rahimian - Alabama A&M University
© IEM 2000
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Motivation:
Government Affects the Economy

Government spending is nearly 1/5 of GDP in 2000
Exports Imports
-4%
Government
Spending
18%
Consumer
Spending
67%
Investment
Spending
19%
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Does the Economy Affect the Government?


Specifically, do macroeconomic conditions
influence national elections?
Political candidates think so...
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Political Quotes



Reagan (1980): “Are you better off than you
were four years ago?”
Clinton (1992): “It’s the economy, stupid!”
Gore/Clinton (2000): “Are you better off than
you were eight years ago?”
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How do we Determine the Condition of the
Economy?

Measuring Macroeconomic Conditions
–
–
–
–
Inflation rate
Unemployment rate
Economic growth rate
International trade and the balance of trade
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Four Questions




How do we measure these?
How well is the economy performing
according to these measures?
How does economic performance influence
national elections?
What influences economic performance?
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Measurement: Inflation

Overall price level is measured by the
Consumer Price Index (CPI) and the GDP
Deflator (DEF)

The inflation rate is the percent change in the
overall price level in the economy over a
given period of time.
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Inflation - CPI Measure


One way to measure inflation is to determine
changes in the cost of a given market basket
of goods and services over time.
Consumer Price Index (CPI): measures the
cost of a market basket of goods and services
(that a typical urban wage earner would
purchase) at a particular date relative to the
cost of that same market basket of goods and
services in a selected base period.
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Inflation - CPI Measure

Inflation Rate: The percentage change in the
value of the consumer price index (CPI) from
one year to the next.
Inflation Rate 1996:Q 2 
[CPI1996:Q 2  CPI1996:Q1 ]
CPI1996:Q1
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100
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Inflation - GDP Deflator Measure


An alternative way of measuring inflation is to
use a broader basket of goods and services;
in particular, the GDP Deflator measures the
price level based on the total amount of
goods and services produced in the economy
each year.
The GDP Deflator measures the cost of an
economy’s production in current-year prices
relative to that year’s production in constant,
or base-year prices.
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Inflation - GDP Deflator Measure

GDP Deflator (DEF): measures the value of
current production in the country at base year
prices
DEF1996:Q1 
Nominal GDP1996:Q1
Real GDP1996:Q1
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Inflation Rate: GDP Deflator Measure

Inflation Rate: The percentage change in the
value of the GDP Deflator from one year to
the next.
Inflation Rate 1996:Q 2 
[DEF1996:Q 2  DEF1996:Q1 ]
DEF1996:Q1
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100
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Measurement: Unemployment


Unemployed: a person who is actively
seeking work but does not currently
have a job.
Labor force: persons 16 years of age
and older who are employed or
unemployed
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Measurement: Unemployment

The unemployment rate is the
percentage of the labor force that is
officially unemployed.
Unemployme nt Rate 
Number Une mployed
100
Labor Force
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Measurement: Economic Growth


Measures of economic growth are based on
how fast a country’s per capita real GDP is
growing.
Real GDP: value of a country’s annual
production of currently produced goods and
services, measured in base year prices
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Measurement: Economic Growth

Per capita real GDP is a country’s level of
real GDP in a specific time period divided by
the number of people in the population at that
time.
PCRGDP1996:Q1 
Real GDP1996:Q1
Population 1996:Q1
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Measurement: Economic Growth

Economic growth is simply the growth rate of
per capita real GDP (PCRGDP) over time.
Growth Rate of Per Capita Real GDP1996:Q 2 
[PCRGDP1996:Q 2  PCRGDP1996:Q1 ]
PCRGDP1996:Q1
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100
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Measurement:
International Trade

Balance of Payments
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Economic Performance:
The Historical Experience
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CPI and the Inflation Rate:
The Historical Record
Consumer Price Index (All items)
180
160
140
100
80
60
40
20
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
1971
1969
1967
1965
1963
1961
0
1959
CPI-Urban
120
Year
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Inflation Rates over the Decades
16
Annual inflation rate
Decade average annual inflation rate
12
The 70's
10
The 80's
8
The Sixties
6
The 90's
4
2
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
0
1960
Annual Inflation Rate (%)
14
Year
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The Unemployment Rate:
The Historical Record
Unemployment rate
12.0
8.0
6.0
4.0
2.0
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
1971
1969
1967
1965
1963
1961
0.0
1959
Percentage
10.0
Year
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Unemployment Rate
12.0
8.0
The 70's
The
80's
6.0
The 90's
4.0
The Sixties
2.0
Annual Rate
Average annual rate by decade
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
0.0
1960
Percentage
10.0
Year
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Economic Growth:
The Historical Record
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International Trade:
The Historical Record
Current Account Balance
(1959-1998)
50,000
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
1971
1969
1967
1965
1963
1961
1959
0
$ millions
-50,000
-100,000
-150,000
-200,000
-250,000
Year
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%age of Nominal GDP
-0.5
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1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
1971
1969
1967
1965
1963
1961
1959
Current Account Balance
(1959-1998)
1.5
1.0
0.5
0.0
-1.0
-1.5
-2.0
-2.5
-3.0
-3.5
-4.0
Year
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Economic Performance:
How are we Doing Today?

Current Conditions
– Inflation?
– Unemployment?
– Economic Growth?
– International Trade?
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Does Economic Performance Affect National
Elections?



Do voters reward economic performance at
the ballot box?
What do economists and political scientists
have to say about this?
Three ways to predict who will win a national
election:
– public opinion polls
– economic models
– Iowa Electronic Markets
© IEM 2000
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Public Opinion Polls

Most objective ones are conducted by independent
organizations
– Research companies
Gallup, Harris
– News outlets
 CBS, New York Times, CNN


Select a representative cross-section of particular
population
– Everyone has an equal chance of being selected
– Opposite of phone-in polls where you can express you
opinion many times
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Public Opinion Polls

Population depends on the subject of the poll
– For general public opinion, from adults over 18
– For election forecasts, registered or likely voters


Example question on the economy:
How would you rate economic conditions in this
country today, excellent, good, only fair, or poor?
Gallup Poll
– 25% Excellent, 49% Good
– National sample of Adults
– August 18-19, 2000
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Public Opinion Polls


Trial heat polls
Now, suppose that the presidential election were
being held today, would you vote for:
– Bush 46% of likely voters
– Gore 45% of likely voters
– Buchanan 1% of likely voters

Registered voters were slightly different:
– Bush 41%
– Gore 48%
– Buchanan 1%

Gallup Poll of August 24-27, 2000
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Limits of Public Opinion Polls

Polls can be inaccurate for many reasons
–
–
–


Registered v. likely voters
Undecided voters
Uninformed voters
Can we determine which candidate people
think will win an election rather than which
candidate they want to win?
Ask this question of informed and involved
people
© IEM 2000
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Iowa Electronic Market



Participants express their opinions by buying
and selling contracts
Contract values are determined by the
election outcome
Example: 2000 Vote Share Market
–
–
3 contracts, one each for Bush, Gore and
Buchanan
Payment at end is based on candidates’ share of 3
candidates’ total popular vote
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Iowa Electronic Market

How does this work?
Prices on the market are predictions of how
well a candidate will do in the election.

Example: Prices on August 28, 2000

–
–
–
Bush
Gore
Buchanan
$0.490
$0.490
$0.021
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Iowa Electronic Market


How accurate are the IEM predictions?
In the last 4 Presidential elections, the
average error
–
–


for major polls = XX%
For IEM = xx%
Check out current markets at:
www.biz.uiowa.edu
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Economic Models

If Americans vote their pocketbooks, then the
state of the economy can be used to predict
Presidential elections
 Fair Model by economist Ray Fair of Yale
University
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The Fair Model of the Presidential Election Vote
– Predicts the percentage of the 2-party vote
gained by the Democratic candidate
– Depends on:





The party currently holding the Presidency
For how many terms
Is an incumbent running
Inflation
Economic growth
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The Fair Model of the Presidential Election Vote

Very accurate model
 Using data from 1880-1960, it predicted the
next 9 elections with a mean absolute error of
2.4 percentage points
 New model using data up to 1996 race is in
Fair.xls spreadsheet
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Presidential Election 2000 Predictions
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Presidential Election 2000 Predictions
Poll Results:








Oct. 1 Predictions
Voter.com
42% Bush 41% Gore
LA Times
48% Bush 42% Gore
Newsweek
43% Bush 46% Gore
NY Times/CBS
39% Bush 42% Gore
WSJ/NBC
42% Bush 45% Gore
CNN/USA Today
46% Bush 46% Bush
Source: WSJ 9/28/00
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Presidential Election 2000 Predictions
IEM Share Prices





Oct. 1 Predictions
Last Prices at Midnight
Bush
0.490
Gore
0.505
Buchannan
0.014
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Presidential Election 2000 Predictions
Economic Model

Oct. 1 Predictions
– Economic Model
– Use Fair.xls
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Questions:



How close were the three predictions to the
actual result?
Why were there some prediction errors?
What is missing?
Microeconomic factors
© IEM 2000
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Extensions:
Predicting Congressional Outcomes


Lewis-Beck model:
Change in actual House seats of the
President’s party is a function of:
–
–
–
the President’s job approval six months before the
election
growth rate in real per capita GDP between first
and second quarters of the election year
whether it is a midterm election
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Lewis-Beck Model


Inputs may be obtained from Assignment 1
and gallup.com
Calculate change in seats using Lewis-Beck
model.xls
© IEM 2000
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Congressional Control Markets


Run every two years
In 2000, there were 4 contracts
–
–
–
–

RH_RS Republican House and Senate
RH_NS Republican House and non-Republican
Senate
NH_RS non-Republican House and Republican
Senate
NH_NS non-Republican House and Senate
Control means 218 Republican House
members, 51 Republican Senators
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2000 Congressional Control Market
Prices as of 10/1/00






RH_RS
RH_NS
NH_RS
NH_NS
0.386
0.021
0.500
0.100
What actually happened?
How well did the Lewis-Beck model predict?
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