Fall 2015
Macroeconomics
Starring Erik Hurst
1
U.S. Non Farm Employment: 1970M1-2015M8
Note: Up through August 2015 (Shaded Years are Recessions)
2
Unemployment Rate: 1970M1 – 2015M8
3
Unemployment Duration: 1970M1 – 2015M8
4
Unemployment Duration: 1970M1 – 2015M8
Increased Extension of Unemployment Benefits?
5
Broad Questions of Interest About Unemployment
• What is a recession?
• Why would unemployment increase at the end of a recession?
• Why has the nature of unemployment coming out of recessions
changed over time?
• Why does unemployment exist?
• Can policymakers affect the unemployment rate?
6
How is Unemployment Measured?
• Standardized Definition of the Unemployment Rate:
Unemployed
= jobless but looking for a job
Labor Force
= #Employed + #Unemployed
Unemployment Rate = (# Unemployed) / (Labor Force)
This is the definition used in most countries, including the U.S.
U.S. data: http://stats.bls.gov/eag.table.html
U.S. measurement details: http://stats.bls.gov/cps_htgm.htm
Issues: Discouraged Workers, Underemployed, Measurement Issues
• Readings: #23, 24 from Reading List
7
Components of Unemployment
• Flow of people into the unemployment pool
o Flow into unemployment from employment (job loss)
o Flow into unemployment from out of labor force (stop being
discouraged)
• Flow of people out of the unemployment pool
o Flow out of unemployment into employment (job finding)
o Flow out of unemployment out of labor force (discouraged workers)
8
A Few More Definitions
• Labor Force Participation Rate
o Labor Force/ Population (age 16+)
• Employment Rate
o Employed / Population (age 16+)
o Employment rate defined out of total population as opposed to labor
force.
o Also referred to as employment to population rate (EPOP).
9
Labor Force Participation Rate: Men
10
Labor Force Participation Rate: Women
11
Employment to Population Rate: Men
12
Employment to Population Rate: Women
13
Types of Unemployment
• Frictional Unemployment: Result of Matching Behavior between Firms and
Workers.
• Structural Unemployment: Result of Mismatch of Skills and Employer Needs
• Cyclical Unemployment: Result of output being below full-employment.
Individuals have the desire to work and the skills to work, yet cannot find a job.
• Is Zero Unemployment a Reasonable Policy Goal?
– No! Frictional and Structural Unemployment may be desirable (unavoidable).
Readings: Reading List #6, 7
14
Why is the Distinction Important?
• How much of the current unemployment is structural vs. cyclical?
• This is a current debate among policy makers (and a question I am trying to
answer in my own research)
• Why could there be structural unemployment?
o Some industries boomed inefficiently during the early 2000s (construction)
and need to retrench. The jobs being created now are not in those industries
(where unemployment is high).
o Some industries were in secular decline during the 2000s (manufacturing).
The jobs being created now are not in those industries.
o Workers in manufacturing and construction need to be reallocated to other
sectors.
15
Some Other Labor Market Facts
16
17
18
19
20
Cohorts entering labor market
around 2000
21
Cohorts entering labor market
around 2000
22
Non-Employment Rate:
Prime Age (21-55) Non-College and College Women
0.60
Solid Line: Data
Dashed Line: 3rd Order Polynomial
0.50
0.40
Less than College
Δ(00-11)=0.080
0.30
0.20
College and More
Δ(00-11)=0.027
0.10
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
0.00
23
Total Employment By Skill (Men and Women)
(January 2000 Normalized to 1)
1.4
1.3
1.2
1.1
1.0
0.9
0.8
High School or Less
Some College
College or More
24
My Current Research
•
Big decline in manufacturing employment during the early 2000s. This
usually depresses wages and employment of non-college individuals.
•
Housing boom during the early 2000s lifted the employment and wages of
lower skilled individuals (by propping up construction and housing related
services).
•
Housing boom “masked” the structural decline in manufacturing. The
manufacturing decline is “permanent” while the housing boom was
temporary.
•
This is the focus of a series of new papers with Kerwin Charles and
Matt Notowidigdo.
•
Preview some background patterns now. Will talk about the identification
later in the course. About 40% of increase in non-employment during the
2000-2012 period can be explained by declining manufacturing.
Total Monthly U.S. Manufacturing Employment (in 1,000s):
1980M1-2014M5
22,000
20,000
~1 Million Jobs Lost
During 1980s and 1990s
18,000
16,000
14,000
12,000
10,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
8,000
Total Monthly U.S. Manufacturing Employment (in 1,000s):
1980M1-2014M5
22,000
20,000
~1 Million Jobs Lost
During 1980s and 1990s
18,000
16,000
14,000
12,000
~4 Million Jobs Lost
Between 2000-2007
(Housing Boom Years)
10,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
8,000
Total Monthly U.S. Manufacturing Employment (in 1,000s):
1980M1-2014M5
22,000
20,000
~1 Million Jobs Lost
During 1980s and 1990s
18,000
~2 Million Jobs
Lost
After 2007
16,000
14,000
12,000
~4 Million Jobs Lost
Between 2000-2007
(Housing Boom Years)
10,000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
8,000
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
U.S. Employment Trends for Non-College Men (age 21-55)
0.45
0.40
Manufacturing + Construction
0.35
0.30
0.25
Manufacturing
0.20
0.15
0.10
Construction
0.05
0.00
0.08
0.02
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
U.S. Employment Trends for Non-College Women (age 21-55)
0.14
Manufacturing + Construction
0.12
0.10
Manufacturing
0.06
0.04
Construction
0.00
Propensity to Have At Least One Year of College (By Birth Cohort)
Some Initial Conclusions
• Decline in the employment rate for men and women is a KEY fact facing
economists and policy makers going forward.
• The decline is even larger among younger workers who didn’t accumulate skill.
• Decline in manufacturing is part of the story. Reduces labor market
opportunities for low skilled workers.
• Housing boom masked the decline (and lowered educational attainment).
• Role of leisure technology for young workers (social media, video games, etc.)
makes not working relatively more attractive today than in past.
32
A Side Question: Why Should We Care About Unemployment?
• Depreciation of Human Capital
o
Individuals lose skills when they sit idle.
• Productive Externalities
o
Working individuals mean fewer wasted resources.
• Social Externalities
o
Individuals not working could increase crime, divorce, etc.
• Individual Self-Worth
o
Individuals not working may have lower marginal utility of
leisure or consumption.
33
Questions We Will Address In This Course
1.
2.
3.
What causes recessions? What causes unemployment?
What caused this recession? Will there be a double dip?
What is the link between housing prices and “real” economic activity
(consumption, production, unemployment, etc.)?
4. What is the link between the banking sector and “real” economic activity?
5. Should we be concerned with inflation? What about deflation?
6. What causes inflation/deflation?
7. How can policy makers (Fed/Congress/President) influence economic activity in
the short run (fight inflation and recessions) and in the long run (promote
economic growth)?
8. What are the pitfalls of government intervention?
9. What makes economies grow in the LONG RUN?
10. How worried should we be about long run government deficits? What about the
“fiscal cliff”?
11. What are the costs/benefits of altering the nature of the Federal Reserve?
34
12. What is the influence of China and India on the U.S. economy?
Caveat #1
• My course takes the perspective of analyzing any large macroeconomy (with
respect to the models we build).
• The examples will come primarily from the U.S. (because that is what I study)
• However, the insights apply equally well to all large developed economies
including:
– The European Union
– Japan
– Canada, Australia, etc. (for the most part).
• The models you will learn in this class also explain consumer, business, and
government behavior for all economies (China, India, etc.).
35
Caveat #2
• The course takes time to build.
• Our goal is to construct and analyze the economy as a whole.
• To do that, we separately build the parts.
• After we build the parts, we put them together to see how they interact.
• At certain points in the class, you may feel that we are losing sight of the big
picture and you may feel lost. That is common.
• But, I promise, by week 7 or 8 everything will come together (it always does).
36
Note
• I have so much material to cover in this course, that we will have a
mandatory extra lecture.
• The course will be comprised of 11 lectures.
• The extra lecture for all sections: October 18th (from 8:45 am – 11:45 am) –
in Gleacher Room 100 (this is a Sunday Morning)
• All are expected to attend.
• See syllabus for full details.
37
TOPIC 1
A Introduction to Macro Data
38
Goals of the Lecture
• What is Gross Domestic Product (GDP)? Why do we care about it?
• How do we measure standard of living over time?
• What are the definitions of the major economic expenditure components?
• What are the trends in these components over time?
• What is the difference between ‘Real’ and ‘Nominal’ variables?
• How is Inflation measured? Why do we care about Inflation?
• What have been the predominant relationships between Inflation and GDP
over the last four decades?
NOTE: This lecture will likely go into next week. This is by design. It does
not mean we will be short-changed on other material later in the class.
39
Gross Domestic Product (GDP)
• GDP is a measure of output.
• Why Do We Care?
– Because output is highly correlated (at certain times) with other things we care
about (standard of living, wages, unemployment, inflation, budget and trade deficits,
value of currency, etc…)
• Formal Definition:
– GDP is the Market Value of all Final Goods and Services Newly Produced on
Domestic Soil During a Given Time Period (different than GNP)
40
“Production” Equals “Expenditure”
• GDP is a measure of Market Production!
• GDP = Expenditure = Income = Y (the symbol we will use)
(in macroeconomic equilibrium)
• What is produced in the market has to show up as being purchased or held by
some economic agent.
• Who are the economic agents we will consider on the expenditure side?
–
–
–
–
Consumers (refer to expenditure of consumers as “consumption”)
Businesses (refer to expenditure of firms as “investment”)
Governments (refer to expenditures of governments as “government spending”)
Foreign Sector (refer to expenditures of foreign sector as “exports”)
41
A Simple Example
• What is “produced” has to be “purchased” by someone (including the
producer).
• Suppose I produce a cell phone. If so, I could:
–
–
–
–
–
sell it to domestic customers (Consumption)
sell it to domestic businesses (Investment)
keep it in my stock room as inventory (Investment)
sell it to domestic government (Government spending)
sell it to foreign consumers, businesses or governments (Export)
42
“Production” Equals “Income”
• What is Produced is Also a Measure of Income.
• If you pay a $1 for something, that $1 has to end up in someone’s pocket as:
Wages/Salary (compensation for workers who make production)
Profits (compensation for self employed)
Rents (compensation for land owners)
Interest (compensation for debt owners)
Dividends (compensation for equity owners)
• Notice, wages are only one component of income (Y does not equal wages)!
(Although, under certain production functions, they will be proportional to each
other).
43
Stop and Pause
• By definition…..
Production = Income = Expenditure = Y
• What is produced has to be purchased by someone (accounting for inventory
changes).
• Value of what is purchased has to end up as income in somebody’s pocket!
• In our class, we realize that the terms are interchangeable in equilibrium.
44
Measuring GDP in Practice
• Production Method: Measure the Value Added summed Across Industries
(value added = sale price - cost of raw materials)
• Expenditure Method: Spending by consumers (C) + Spending by businesses
(I) + Spending by government (G) + Net Spending by
foreign sector (NX)
• Income Method:
Labor Income (wages/salary) +
Capital Income (rent, interest, dividends, profits).
• In our class, we will model the production side of economy (supply side) and
the expenditure side of the economy (demand side).
• Prices will always adjust to equate supply and demand such that Y (production)
45
always equals Y (expenditure).
What GDP is NOT!
• GDP is not, or never claims to be, an absolute measure of well-being!
– Size effects : But even GDP per capita is not a perfect measure of welfare
•
“The gross national product does not allow for the health of our children, the quality of
their education, or the joy of their play. It does not include the beauty of our poetry or
the strength of our marriages, the intelligence of our public debate or the integrity of our
public officials. It measures neither our courage, nor our wisdom, nor our devotion to
our country. It measures everything, in short, except that which makes life worthwhile,
and it can tell us everything about America except why we are proud to be Americans.”
– U.S. Senator Robert F. Kennedy, 1968
46
More on What GDP Is Not
• GDP Does Not Measure:
–
–
–
–
–
Non-Market Activity (home production, leisure, black market activity)
Environmental Quality/Natural Resource Depletion
Life Expectancy and Health
Income Distribution
Crime/Safety
• Remember how we measure GDP…(i.e., how does one measure “safety”).
• Ideally, what we would like to measure is quality of one’s life:
– Present discounted value of utility from one’s own consumption and leisure
and that of one’s loved ones.
• Readings: #17-22, 25-26
47
Defining the Expenditure Components (formally)
• Consumption (C):
– The Sum of Durables, Non-Durables and Services Purchased Domestically by NonBusinesses and Non-Governments (ie, individual consumers).
– Includes Haircuts (services), Refrigerators (durables), and Apples (non-durables).
– Does Not Include Purchases of New Housing.
• Investment (I):
– The Sum of Durables, Non-Durables and Services Purchased Domestically by
Businesses
– Includes Business and Residential Structures, Equipment and Inventory Investment
– Land purchases are NOT counted as part of GDP (land is not produced!!)
– Stock purchases are NOT counted as part of GDP (stock transactions do NOT
represent production – they are saving!)
There is a difference between financial and economic investment!!!!!!!
48
More On Expenditure/Production Components
• Government Spending (G): Goods and Services Purchased by the domestic
government.
• For the U.S., 2/3 of this is at the state level (police and fire protection, school
teachers, snow plowing) and 1/3 is at the federal level (President, Post Office,
Missiles).
• NOTE: Welfare and Social Security are NOT Government Spending. These
are Transfer Payments. Nothing is Produced in this Case.
• Net Exports (NX): Exports (X) - Imports (IM);
– Exports:
– Imports:
The Amount of Domestically Produced Goods Sold on Foreign Soil
The Amount of Goods Produced on Foreign Soil Purchased
Domestically.
49
Summary of the Demand Side of Economy
• Aggregate Expenditure:
Y = C + I + G + X – IM
(A key equation in our class)
• Only four economic agents can “spend” on domestic production
Domestic consumers (C)
Domestic firms (I)
Domestic governments (G)
Foreign consumers, firms, and governments (X)
• We will develop models for each sub component of the expenditure side of the
economy (C, I, G, and NX).
50
Measuring Expenditure (Demand Side)
• Only include expenditures for goods that are “produced”.
– If I give $10 to a movie theater to watch a movie, it is counted as expenditure.
– If I give $10 to my nephew for a birthday present, it is not counted as expenditure.
– If I give $10 to the ATM machine to put in my savings account, it is not counted as
expenditure.
• The second example would be considered a “transfer” (once I give $10 to my
nephew, he can go to the movies if he wanted to – once that $10 is spent, it will
show up in GDP).
– “Transfers” are defined as the exchange of economic resources from one economic
agent to another when no goods or services are exchanged.
• The third example is considered “saving” (I am delaying expenditure until the
future). Once I spend the $10 in the future, it will show up in GDP. In the
meantime, someone may borrow the $10 from the bank and spend it.
– Interest rates will adjust to make sure savings equal investment.
51
Some Examples of GDP Measurement
• Thinking about imports
Y = C + I + G + X – IM
• Thinking about inventories (storing production….)
Y = C + I + G + X – IM
• Distinguishing between government spending and “transfers”.
Y = C + I + G + X – IM
52
Preview of Supply Side of Economy
• Production:
Y = f(A, N, K, other inputs like oil)
A = technology,
N = labor input,
K = capital (machine) input
• We will develop models/intuition for A, N, K and other inputs (like oil)
• N will be determined in the labor market (labor demand and labor supply)
• K will be determined by past investment behavior (net of depreciation).
53
Where We are Headed
54
The role of “prices”
• “Prices” ensure that we are always in equilibrium
• 4 prices in our class
Price of output (e.g., CPI)
P
Price of labor (real wages)
W/P
Price of money (loans – real interest rates)
r
Price of foreign currency (exchange rate)
$ or e
• We will develop (from fundamentals) these 4 markets in our class.
• All are determined by “supply” forces and “demand” forces.
55
The 4 Markets We Will Build
1)
Labor Demand vs. Labor Supply (determines N and W/P)
Necessary to compute the supply side of economy
Key to where recessions come from (frictions in the labor market)
2)
IS-LM market (determines r and Y (via I))
Interest rates determine firm investment
Key to central bank policy (sets r)
Key to understanding banking crises.
3)
Aggregate Demand vs. Aggregate Supply (determines P and Y)
Key to understanding where inflation comes from.
56
The 4 Markets We Will Build (continued)
4)
Foreign Exchange Market (determines value of currency and NX)
We will focus on this market in last week of class.
Key to understanding the interaction of macro link across countries.
Notice:
• All markets help to pin down the level of Y in the economy
• These four markets (and their components) will determine everything we want
to know about the macroeconomy (production, inflation, economic growth,
unemployment, interest rates, budget deficits, trade deficits, etc.)
• For the next 7 weeks, we will build the underpinnings of these markets. In
doing so, we will uncover how these markets work and what factors influence
these markets.
57
An Important Equation
58
Defining Savings (Store this Away!)
Yd = Disposable Income = Y - T + Tr (definition)
• T
• Tr
= Taxes
= Transfers (ie, Welfare)
Yd = C + SHH (Only can save or spend disposable income)
• SHH
(1)
(2)
= Personal (Household or Private) Saving
SHH = Y - T + Tr – C <<Combine (1) and (2)>>
(3)
• Personal Savings Rate = SHH/Yd
•
For simplicity, we are going to abstract from business saving (things like retained
earnings and depreciation). For those interested in more of these accounting
relationships, see the text.
59
A Look at Actual U.S. Household Saving Rates:
1970M1 – 2015M7
Remember: Shaded areas are recessions.
60
Saving Identities (continued)
Sgovt = T - (G + Tr)
(Definition of government surplus)
(4)
• Sgovt = Government (Public) Saving
• Includes Federal, State and Local Saving
• What government collects (T) less what they pay out (G and Tr)
S
= SHH + Sgovt = Y - C - G = I + NX (combine (3) and (4))
• S
(5)
= National Savings
Restate (5):
S
S
= Y-C–G
= I + NX
<<Combine (3) and (5)>>
<<Combine (6) and Y = C+I+G+NX>>
(6)
(7)
61
Summary
S = I + NX
We will use this equation for the rest of the class!
National savings, goes into a “bank”.
Firms looking to borrow, go to the “bank”.
Firms can only borrow what is in the “bank”.
In a world where NX = 0, interest rates will adjust such that savings will always
equal investment (I=S – this will be our IS curve later in the course).
What is the role of NX? (International savings – discuss later in class)
62
Understanding Prices and Inflation
63
Prices and Inflation
• Why is it important to measure “prices” of goods and services?
o Prices are a key metric of measurement (we measure GDP in prices).
- The metric changes over time given that prices change over time.
o Changes in prices (inflation) are of independent interest in the
macroeconomy.
- Inflation is just the percentage growth rate in prices.
64
Prices as Measurement
• Measures macro prices of goods and services through “price indices”
• Price Indices track the relative change in the prices for a “basket” of many
goods (intended to be representative of all goods) compared to the same basket
of goods in a “base year”.
• The base year is the anchor for the price index and all subsequent price indices
are relative to the base year.
• GDP Deflator (one prominent price index):
Value of Current Output at Current Prices /
Value of Current Output at Base Year Prices
• Another prominent price index is the CPI (consumer price index) – measures
price changes of consumer goods. I will often use the CPI as our measure65of a
price index in this class.
Example of Price Index Calculation (Continued)
• Nominal GDP is output valued at Current Prices
• Comparing Nominal GDPs over time can become problematic. Confuse
Changes in Output (production) with Changes in Prices
• Real GDP is output valued at some Constant Level of Prices (prices in a base
year).
Real GDP(t) = Nominal GDP(t) / Price Index (t)
• Growth in Real GDP:
% Δ in Real GDP = [Real GDP (t+1) - Real GDP (t)]/Real GDP (t)
or (approximately)
% Δ in Real GDP = % Δ in Nominal GDP - % Δ in P
• See Supplemental Notes 1 (Real vs. Nominal Variables) for examples.
66
Technical Notes on Price Indices
• Need to Pick a Basket of Goods (cannot measure all prices)
• ‘Ideal/Representative’ Basket of Goods Changes Over Time
– Invention (Computers, Cell Phones, VCRs, DVDs).
– Quality Improvements (Anti-Lock Brakes)
– Could differ by place or person?
• Criticism of Price Indices: Part of the Change in Prices Represents a Change in
Quality - Actually, not measuring the same goods in your basket over time.
• How do we account for “sales”?
• Additionally - technology advances drive down the price of ‘same’ goods over
time.
67
Technical Notes on Price Indices
• Boskin Report (1996) Concludes that CPI Overstates Inflation by 1.1% per
year.
• Overstating Inflation means understated Real GDP increases - makes it appear
that the U.S. Economy has Grown Slower Over Time. (Same for Stock Market,
Housing Prices, Wages - any Nominal Measure).
• Measures to Get Around Problems with CPI - Chain Weighting
– Read Text to get a sense of chain weighting.
• Readings: #16, 27, 28, 29
68
Technical Notes on Price Indices
• Which is better: Real or Nominal?
– In this class, we will focus on the ‘Real’! We are trying to measure changes
in production, expenditures, income, standard of livings, etc. We will
separately focus on the changes in prices.
– From now on, both in the analytical portions and the data portions of the
course, we will assume everything is real unless otherwise told.
• ie, Y = Real GDP, C = Real Consumption, G = Real Government
Purchases, etc...
69
Some More New Research
• Create price indices at state and local levels.
• Such series have never been systematically created within the U.S.
• Increased demand for such series (as more research is taking place exploiting
cross U.S. variation – we will discuss this later in the course).
• Work in progress
o
o
o
Scanner data which includes grocery goods and small durables.
Housing data
Energy prices
70
My Scanner Index vs BLS Food Index (2000M1 = 1)
71
Variation Across States (Each Circle is a U.S. State)
72
Recessions and Inflation in U.S. Over Last 40 Years
73
What is a Recession?
• “Official Rule of Thumb” - 2 or more quarters of negative real GDP growth
• Most Economies are usually not in recession
– U.S. average postwar expansion: 50 months
– U.S. average postwar recession: 11 months
– Previous Recession: 19 months (December 2007 – June 2009)
– Previous Expansion: 71 months (January 2002 - November 2007)
– The 1990s experienced the longest expansion since 1850 (the second longest was
106 months ; 1961-1969)
– For Information on Business Cycle Dates see: http://www.nber.org/cycles.html
74
A Look at U.S. Nominal GDP: 1970Q1 – 2015Q2
75
A Look at U.S. Inflation: 1970M1 – 2015M7
76
A Look at U.S. Real GDP: 1970Q1 – 2015Q2
77
Real GDP and Inflation Over the Last Three Decades?
High or Rising Inflation:
73-75
79-80
07-08
Low or Falling Inflation:
81-83
90-91
96-00 (sustained)
01-02
High Growth in GDP:
83-86
96-00 (sustained)
Negative Growth in GDP:
74-75
79-80
81-83
08-09
90-91
01-02
08-09
1) Sometimes Negative Growth in GDP and Rising Inflation (70s)
2) Sometimes Negative Growth in GDP and Falling Inflation (80s and 90s)
Need Theory to Explain Both Sets of Facts!!!!
78
More On Recessions
Dates
2/61 - 11/69
12/69 - 10/70
11/70 - 10/73
11/73 - 2/75
3/75 - 12/79
1/80 - 6/80
7/80 - 6/81
7/81 - 10/82
11/82 - 6/90
7/90 - 2/91
3/91 - 3/01
4/01 - 12/01
1/02 - 11/07
12/07 - 6/09
7/09 - current
Expansion
Recessions
Expansion
Recession
Expansion
Recession
Expansion
Recession
Expansion
Recession
Expansion
Recession
Expansion
Recession
Expansion
Length
106 months
11 months
36 months
16 months
58 months
6 months
12 months
16 months
92 months
8 months
121 months
8 months
71 months
19 months
84 months
79
Great Moderation?
Dates
2/61 - 11/69
12/69 - 10/70
11/70 - 10/73
11/73 - 2/75
3/75 - 12/79
1/80 - 6/80
7/80 - 6/81
7/81 - 10/82
11/82 - 6/90
7/90 - 2/91
3/91 - 3/01
4/01 - 12/01
1/02 - 11/07
12/07 - 6/09
7/09 - current
Expansion
Recessions
Expansion
Recession
Expansion
Recession
Expansion
Recession
Expansion
Recession
Expansion
Recession
Expansion
Recession
Expansion
Length
106 months
11 months
36 months
16 months
58 months
6 months
12 months
16 months
92 months
8 months
121 months
8 months
71 months
19 months
72 months
49 months of recession in
21 years (1961-1982)
The Great Moderation
16 months of recession in
24 years (1982-2007)
80
Is the Great Moderation Dead?
• I do not think so….
My interpretation:
Great Moderation refers to the fact that the economy is better at minimizing the
impact of any given shock now relative to 30 years ago.
It does not mean that:
There will not be bad shocks
There will not be “new” shocks
Why?
The economy is more flexible (inventory management, credit)
We have gotten better at conducting macroeconomic policy!
81
Foreshadowing the rest of the course
• Assume aggregate demand (drawn in {Y,P} space) slopes down
I will prove this to you later in the course
• Assume short run aggregate supply (drawn in {Y,P} space) slopes up
I will prove this to you later in the course
I will also distinguish between short run and long run aggregate supply
82
Foreshadowing the Rest of the Course: Demand Shocks
The relationship between inflation and output when aggregate demand shifts:
Suppose we are in long run equilibrium at point (a) (AD = SRAS = LRAS)
Long Run AS
Short Run AS
P
P
P’
a
b
AD’
AD
Y
Y’ Y*
If the economy receives a negative aggregate demand shock, short run equilibrium
will move from point (a) to point (b). Output will fall (from Y* to Y’). Prices will fall
(from P to P’).
Demand shocks cause prices and output to move in the same direction.
(You should be able to illustrate a positive demand shock)
83
Foreshadowing the Rest of the Course: Supply Shocks
The relationship between inflation and output when aggregate supply shifts:
Suppose we are in long run equilibrium at point (a) (AD = SRAS = LRAS)
Short Run AS’’
Long Run AS
P
P’’
Short Run AS
c
a
P
AD’
AD’’
Y’’
Y*
AD
Y
If the economy receives a negative short run aggregate supply shock, short run equilibrium
will move from point (a) to point (c). Output will fall (from Y* to Y’’). Prices will rise
(from P to P’’).
Supply shocks cause prices and output to move in opposite directions.
(You should be able to illustrate a positive supply shock)
84
Business Cycles vs. Long Run Growth
85
Macroeconomic Goals
Promote Economic Growth
o
o
o
Minimize uncertainty
Minimize distortions in the economy (create level playing field)
Create incentives for efficient economic transactions
o
Bottom line: Maximize “trend” growth
Promote Economic Stability
o
o
Keep the unemployment rate low
Keep inflation in check
o
Refer to this as managing “business cycles” – minimize the deviations (cycles)
around the trend.
Note: Lower uncertainty leads to greater economic activity
86
Why We Care About Inflation
87
Interest Rates
i0,1
=
the nominal interest rate between periods 0 and 1
(the nominal return on the asset)
πe0,1 =
the expected inflation rate between periods 0 and 1
re0,1 =
the expected real interest rate between periods 0 and 1
Definitions
re0,1 = i0,1 - πe0,1 (or i0,1 = πe0,1 + re0,1)
ra0,1 = i0,1 - πa0,1 (or i0,1 = πa0,1 + ra0,1)
where ra and πa are the actual real interest rate and inflation
88
Interest Rate Notes
• The Formula given is approximate. The approximation is less accurate the
higher the levels of inflation and nominal interest rates. The exact formula is re
= (1 + i) / (1 + лe) - 1
• Central Banks are very interested in r since it may affect the savings decisions
of households and definitely affects the investment decisions of firms. The
press talks about Central Banks setting i, but the Central Banks are really trying
to set r.
• 3 easy ways of measuring expected inflation:
– Recent actual inflation (see http://www.clev.frb.org).
– Survey of forecasters (see http://www.phil.frb.org/econ/liv/welcom.html).
– Interest rate spread on nominal vs. inflation-indexed securities (WSJ).
• See http://www.phil.frb.org/econ/spf/spfpage.html for other macro forecasts
89
Why We Care About Inflation
• Note: We will have a whole lecture on this later in the course
• Inflation is Unpredictable
• Indexing Costs (even if you know the inflation rate - you have to deal with it).
• Menu Costs (have have to go and re-price everything)
• Shoe-Leather Costs (you want to hold less cash - have to go to the bank more
often).
• Caveat: There may be some benefits to small inflation rates - more on this later.
90
Why We Care About Inflation
• An Example of how inflation can affect real returns.
• Suppose we agree that a real rate of 0.05 over the next year is fair.
– borrowing rate, salary growth rate, etc.
• Suppose we also agree that expected inflation over the next year is 0.07.
• We should then set the nominal return equal to 0.12 (i = re + лe)
Summary:
i = 0.12
re = 0.05
лe = 0.07
91
Why We Care About Inflation
• Suppose that actual inflation is 0.10 (лa > лe)
In this case, ra = 0.02 (ra = i - лa)
Borrowers/Firms are better off
Lenders/Workers worse off
• Suppose that actual inflation is 0.03 (лa < лe)
In this case, ra = 0.09 (ra = i - лa)
Borrowers/Firms are worse off
Lenders/Workers better off
It has been shown that higher inflation rates are correlated with more variability.
People/Firms Don’t Like the Uncertainty
92
Bonus: Understanding Housing Markets
93
Average Annual Real Price Growth By US State
State
AK
AL
AR
AZ
CA
CO
CT
DC
DE
FL
GA
HI
IA
ID
IL
IN
1980-2000
-0.001
0.000
-0.009
-0.002
0.012
0.012
0.012
0.010
0.011
-0.002
0.008
0.004
-0.001
-0.001
0.010
0.002
2000-2007 2000-13
0.041
0.015
0.024
-0.001
0.023
0.001
0.061
0.001
0.066
0.013
0.012
0.001
0.044
0.006
0.081
0.038
0.053
0.009
0.068
0.005
0.019
-0.013
0.074
0.025
0.012
0.001
0.047
0.002
0.030
-0.006
0.020
-0.010
State
MT
NC
ND
NE
NH
NJ
NM
NV
NY
OH
OK
OR
PA
RI
SC
SD
1980-2000
0.003
0.008
-0.010
-0.002
0.014
0.015
-0.002
-0.005
0.020
0.003
-0.019
0.009
0.008
0.017
0.007
0.002
2000-2007 2000-2013
0.049
0.016
0.022
-0.003
0.033
0.021
0.007
-0.003
0.041
0.007
0.058
0.013
0.043
0.004
0.060
-0.016
0.051
0.014
-0.001
-0.016
0.019
0.005
0.051
0.006
0.042
0.010
0.059
0.011
0.025
-0.001
0.025
0.009
94
Average
0.011
0.036
0.005
Average Annual Real Price Growth By US State
State
AK
AL
AR
AZ
CA
CO
CT
DC
DE
FL
GA
HI
IA
ID
IL
IN
1980-2000
-0.001
0.000
-0.009
-0.002
0.012
0.012
0.012
0.010
0.011
-0.002
0.008
0.004
-0.001
-0.001
0.010
0.002
2000-2007 2000-13
0.041
0.015
0.024
-0.001
0.023
0.001
0.061
0.001
0.066
0.013
0.012
0.001
0.044
0.006
0.081
0.038
0.053
0.009
0.068
0.005
0.019
-0.013
0.074
0.025
0.012
0.001
0.047
0.002
0.030
-0.006
0.020
-0.010
State
MT
NC
ND
NE
NH
NJ
NM
NV
NY
OH
OK
OR
PA
RI
SC
SD
1980-2000
0.003
0.008
-0.010
-0.002
0.014
0.015
-0.002
-0.005
0.020
0.003
-0.019
0.009
0.008
0.017
0.007
0.002
2000-2007 2000-2013
0.049
0.016
0.022
-0.003
0.033
0.021
0.007
-0.003
0.041
0.007
0.058
0.013
0.043
0.004
0.060
-0.016
0.051
0.014
-0.001
-0.016
0.019
0.005
0.051
0.006
0.042
0.010
0.059
0.011
0.025
-0.001
0.025
0.009
95
Average
0.011
0.036
0.005
Average Annual Real Price Growth By US State
State
AK
AL
AR
AZ
CA
CO
CT
DC
DE
FL
GA
HI
IA
ID
IL
IN
1980-2000
-0.001
0.000
-0.009
-0.002
0.012
0.012
0.012
0.010
0.011
-0.002
0.008
0.004
-0.001
-0.001
0.010
0.002
2000-2007 2000-13
0.041
0.015
0.024
-0.001
0.023
0.001
0.061
0.001
0.066
0.013
0.012
0.001
0.044
0.006
0.081
0.038
0.053
0.009
0.068
0.005
0.019
-0.013
0.074
0.025
0.012
0.001
0.047
0.002
0.030
-0.006
0.020
-0.010
State
MT
NC
ND
NE
NH
NJ
NM
NV
NY
OH
OK
OR
PA
RI
SC
SD
1980-2000
0.003
0.008
-0.010
-0.002
0.014
0.015
-0.002
-0.005
0.020
0.003
-0.019
0.009
0.008
0.017
0.007
0.002
2000-2007 2000-2013
0.049
0.016
0.022
-0.003
0.033
0.021
0.007
-0.003
0.041
0.007
0.058
0.013
0.043
0.004
0.060
-0.016
0.051
0.014
-0.001
-0.016
0.019
0.005
0.051
0.006
0.042
0.010
0.059
0.011
0.025
-0.001
0.025
0.009
96
Average
0.011
0.036
0.005
Average Annual Real Price Growth By US State
State
AK
AL
AR
AZ
CA
CO
CT
DC
DE
FL
GA
HI
IA
ID
IL
IN
1980-2000
-0.001
0.000
-0.009
-0.002
0.012
0.012
0.012
0.010
0.011
-0.002
0.008
0.004
-0.001
-0.001
0.010
0.002
2000-2007 2000-13
0.041
0.015
0.024
-0.001
0.023
0.001
0.061
0.001
0.066
0.013
0.012
0.001
0.044
0.006
0.081
0.038
0.053
0.009
0.068
0.005
0.019
-0.013
0.074
0.025
0.012
0.001
0.047
0.002
0.030
-0.006
0.020
-0.010
State
MT
NC
ND
NE
NH
NJ
NM
NV
NY
OH
OK
OR
PA
RI
SC
SD
1980-2000
0.003
0.008
-0.010
-0.002
0.014
0.015
-0.002
-0.005
0.020
0.003
-0.019
0.009
0.008
0.017
0.007
0.002
2000-2007 2000-2013
0.049
0.016
0.022
-0.003
0.033
0.021
0.007
-0.003
0.041
0.007
0.058
0.013
0.043
0.004
0.060
-0.016
0.051
0.014
-0.001
-0.016
0.019
0.005
0.051
0.006
0.042
0.010
0.059
0.011
0.025
-0.001
0.025
0.009
97
Average
0.011
0.036
0.005
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Inflation Adjusted Housing Price Growth in the U.S.
0.10
0.05
0.00
-0.05
-0.10
-0.15
98
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Housing Market: New York
0.20
0.15
0.10
0.05
0.00
-0.05
-0.10
-0.15
99
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Typical “Local” Cycle: California
0.30
0.20
0.10
0.00
-0.10
-0.20
-0.30
-0.40
100
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Typical “Local” Cycle: Nevada
0.40
0.30
0.20
0.10
0.00
-0.10
-0.20
-0.30
-0.40
101
Average Annual Real Price Growth Across Countries
State
Belgium
Canada
Germany
Denmark
Spain
Finland
France
UK
Ireland
Italy
Japan
Luxembourg
Norway
Sweden
S. Africa
USA
1980-2000
0.021
0.007
0.000
0.009
0.014
0.008
0.011
0.026
0.038
0.003
0.011
0.035
0.012
-0.006
-0.024
0.012
2000-2007
0.049
0.061
-0.018
0.069
0.094
0.059
0.084
0.075
0.073
0.052
-0.034
0.073
0.043
0.060
0.112
0.048
2000-13
0.033
0.047
-0.007
0.013
0.015
0.028
0.041
0.032
-0.004
0.009
-0.025
0.039
0.039
0.039
0.051
0.005
102
Average
0.011
0.056
0.022
-0.15
1976:Q1
1977:Q1
1978:Q1
1979:Q1
1980:Q1
1981:Q1
1982:Q1
1983:Q1
1984:Q1
1985:Q1
1986:Q1
1987:Q1
1988:Q1
1989:Q1
1990:Q1
1991:Q1
1992:Q1
1993:Q1
1994:Q1
1995:Q1
1996:Q1
1997:Q1
1998:Q1
1999:Q1
2000:Q1
2001:Q1
2002:Q1
2003:Q1
2004:Q1
2005:Q1
2006:Q1
2007:Q1
2008:Q1
2009:Q1
2010:Q1
2011:Q1
2012:Q1
2013:Q1
2014:Q1
Real House Price Growth in Spain
(Annual Appreciation)
0.25
0.20
0.15
0.10
0.05
0.00
-0.05
-0.10
103
-0.20
1976:Q1
1977:Q1
1978:Q1
1979:Q1
1980:Q1
1981:Q1
1982:Q1
1983:Q1
1984:Q1
1985:Q1
1986:Q1
1987:Q1
1988:Q1
1989:Q1
1990:Q1
1991:Q1
1992:Q1
1993:Q1
1994:Q1
1995:Q1
1996:Q1
1997:Q1
1998:Q1
1999:Q1
2000:Q1
2001:Q1
2002:Q1
2003:Q1
2004:Q1
2005:Q1
2006:Q1
2007:Q1
2008:Q1
2009:Q1
2010:Q1
2011:Q1
2012:Q1
2013:Q1
2014:Q1
Real House Price Growth in Ireland
(Annual Appreciation)
0.30
0.25
0.20
0.15
0.10
0.05
0.00
-0.05
-0.10
-0.15
104
-0.10
1976:Q1
1977:Q1
1978:Q1
1979:Q1
1980:Q1
1981:Q1
1982:Q1
1983:Q1
1984:Q1
1985:Q1
1986:Q1
1987:Q1
1988:Q1
1989:Q1
1990:Q1
1991:Q1
1992:Q1
1993:Q1
1994:Q1
1995:Q1
1996:Q1
1997:Q1
1998:Q1
1999:Q1
2000:Q1
2001:Q1
2002:Q1
2003:Q1
2004:Q1
2005:Q1
2006:Q1
2007:Q1
2008:Q1
2009:Q1
2010:Q1
2011:Q1
2012:Q1
2013:Q1
2014:Q1
Real House Price Growth in Japan
(Annual Appreciation)
0.15
0.10
0.05
0.00
-0.05
105
80.00
1976:Q1
1977:Q1
1978:Q1
1979:Q1
1980:Q1
1981:Q1
1982:Q1
1983:Q1
1984:Q1
1985:Q1
1986:Q1
1987:Q1
1988:Q1
1989:Q1
1990:Q1
1991:Q1
1992:Q1
1993:Q1
1994:Q1
1995:Q1
1996:Q1
1997:Q1
1998:Q1
1999:Q1
2000:Q1
2001:Q1
2002:Q1
2003:Q1
2004:Q1
2005:Q1
2006:Q1
2007:Q1
2008:Q1
2009:Q1
2010:Q1
2011:Q1
2012:Q1
2013:Q1
2014:Q1
Real House Price Index in South Korea
200.00
180.00
160.00
140.00
120.00
100.00
106
Equilibrium in Housing Markets
Fixed Supply
PH
Demand
QH
107
Equilibrium in Housing Markets
Fixed Supply
PH’
PH
Demand
QH
108
Equilibrium in Housing Markets
Fixed Supply
Supply Eventually Adjusts
PH’
PH”
PH
Demand
QH
109
How Does Supply Adjust?
•
Build on Vacant Land
•
Convert Rental or Commercial Property
•
Build Up
•
Build Out (Suburbs)
•
Build Way Out (Create New Cities)
•
Some of these adjustments can take considerable amounts of
time.
Caveat: Gentrification/Agglomeration can lead to sustained
increases in house prices.
110
Why Do House Prices Cycle?
•
Supply and demand forces.
•
When demand increases (increasing prices), supply
eventually adjusts (build more houses).
•
The increase in housing supply moderates price growth.
•
Housing supply – in the long run – is very elastic (convert
old properties, build on vacant land, create new cities,
etc.).
111
U.S Quarterly Housing Starts (in 1,000s): 1970M1-2015M7
112
What Should We Expect?
o
Housing prices have – for the most part - stabilized in
nominal terms.
o
We should expect annual real housing price growth of
somewhere in the range of 0% to 3% nominal in the
medium run.
o
Housing market will not be “rebounding” toward 2006 levels
anytime soon.
- Have a glut of existing supply
- No reason to expect a large housing demand shock