FIN 30220: Macroeconomic
Analysis
Measuring the U.S. Economy
U.S. GDP of $17 Trillion represents approximately one fifth of
total worldwide production ($85 Trillion) and makes the United
States the largest single country economy on the planet!!
18
16
14
12
10
8
6
4
2
0
Note: 20013 GDP estimates measured on a Purchasing Power Parity Basis
* Source: CIA Factbook
Principle #1: What exactly are you trying to measure? Is your definition consistent with
what you are trying to measure?
GDP is the standard benchmark for
economic well being. Is it a good indicator
of well being?
VS
1950: $275B
Ratio
2010: $14,600B
1950: $1,696B
1950: $10,941
1950: $20,000
2010: $12,973B
2010: $42,120
2010: $50,233
2005
Dollars
2005 Dollars
2008 Dollars
GDP is the standard
benchmark for economic 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?
The Genuine Progress
indicator corrects for social
“bads”
VS
Principle #2: How is your variable measured?
Gross Domestic Product measures the current market value of all goods and
services produced within a country’s borders over a certain time period (usually
a quarter)
Farmer A produces 1,000
bushels of Apples (Apples
cost $10/bushel)
Farmer B produces 2,000
bushels of Corn (Corn costs
$15/bushel)
GDP = ($10)(1,000) + ($15)(2,000) = $40,000
Suppose that Intel
produces 1,000 computer
chips (P = $100)
100 Chips sold to
consumers
Value Added Approach
900 Chips
sold to Dell
$100,000
$0
Sales
Materials Expenses
$100,000
$500,000
- $90,000
$40,000
Dell produces 500
computers (P = $1,000)
(The remaining 400 chips were added to
Dell’s inventories)
$450,000
Total = $550,000
Sales
Materials Expenses
Change in Inventories
Example: Microsoft
Sales: $600,000
Expenses: $420,000
• Labor Costs: $200,000
• R&D Costs: $50,000
• Materials: $100,000
• Lease: $20,000
• Utilities: $10,000
• Equipment Purchase: $40,000
Inventories:
• BOY: $620,000
• EOY: $640,000
Value Added:
$600,000
- $220,000 (Non-Labor Exp)
+ $40,000 (Equipment Inv)
+ $20,000 (Inv. Investment)
+ $50,000 (R&D) – NEW
$490,000
Goods & Services (GDP)
Product Markets
Expenditures
Income
Factor Markets
Factor Services
The Circular Flow of Payments suggests that we could also
calculate GDP by measuring total expenditures on the goods
and services produced
Y  C  I G
G
GDP
Consumer Expenditures
Durables
Non-Durables
Services
Government
Purchases
(Federal, State,
and Local)
Gross Business Investment
Structures
Equipment
Inventories
Residential Investment
Suppose that Intel
produces 1,000 computer
chips (P = $100)
100 Chips sold to
consumers
Expenditure Approach
900 Chips
sold to Dell
$0
$40,000
Inventory Investment
$510,000
Consumer Durables
Dell produces 500
computers (P = $1,000)
(The remaining 400 chips were added to
Dell’s inventories)
Total = $550,000
What’s so Gross about GDP?
Suppose that we have the following information from GM’s financial
statements
Sales: $300M
Change in Inventories: $20M
$300,000
- $150,000
$20,000
Sales (000s)
Materials Expenses (000s)
Change in Inventories (000s)
Total = $170,000
Materials Costs: $150M
Depreciation: $5M
Strictly speaking, depreciation should be counted as a cost of production.
GDP calculations do not include depreciation expenses!
•Exports of Goods and Services
•US Citizens Working Abroad
US Acquisition of Foreign Assets
Foreign Acquisition of US Assets
•Imports of Goods and Services
•Foreign Citizens Working in the US
BMW operates a manufacturing facility in Spartanburg South Carolina.
Meanwhile, Nike operates 73 production facilities in Thailand. How should we
count this production?
$130,000
- $70,000
$60,000
Value Added (000s)
Labor Costs (000s)
Profits (000s)
$400,000
- $50,000
$350,000
Value Added (000s)
Labor Costs (000s)
Profits (000s)
Gross Domestic Product = Total Production within US borders
Gross National Product = Total Production by US Citizens
The $60,000 in profits from BMW accrue to foreign nationals and
should not be counted in US GNP. However, GNP would need to
include the profits from Nike’s Thailand plants.
BMW operates a manufacturing facility in Spartanburg South Carolina.
Meanwhile, Nike operates 73 production facilities in Thailand. How
should we count this production?
$130,000
- $70,000
$60,000
Value Added (000s)
$400,000
- $50,000
$350,000
Labor Costs (000s)
Profits (000s)
Value Added (000s)
Labor Costs (000s)
Profits (000s)
GDP = $130,000
GNP = $70,000 + $350,000 = $420,000
$420,000 = $130,000 +($350,000 - $60,000)
GNP
GDP
Net Factor Payments
With the global economy, we need to keep track of
expenditures between the US and the rest of the world as
well as domestic expenditures
Y  C  I  G  NX
G
GDP
Government
Purchases
Consumer Expenditures
Gross Investment
Net Exports = Exports - Imports
GDP is calculated using a method of double entry accounting – each
dollar of production should have a corresponding expenditure.
GDP: 2014Q1
Category
Amount (B) % of Total
Consumption
$11,792
69%
Gross Investment
$2,694
16%
Government
$3,116
18%
Net Exports
GDP
-$501
$17,101
-3%
100%
Recall that total income (national income) in the US should accrue from the
production undertaken by American citizens
Gross Domestic Product = $17,101B
+ Net Factor Payments = $235B
First, we need to correct for
income earned abroad as
well as domestic production
accruing to foreign nationals
Gross National Product = $17,336B
- Depreciation Expense = $2,721B
Now, recall that depreciation is
an expense that should be
deducted as a production cost
Net National Product = $14,615B
- Indirect Taxes = $198B
National Income = $14,417B
Finally, we need to correct for
indirect taxes/transfers
(essentially, sales taxes)
National Income by Source: 2014Q1
Category
Amount(B)
% of Total
Wages
$9,040
62%
Proprietor’s Income
$1,366
9%
Rental Income
$611
4%
Income on Assets
$2,030
14%
Transfer receipts
$2,504
17%
Less Contributions
- $1,134
6%
National Income
$14,417
100%
To get to the flow of funds accounts, begin with GDP equals aggregate
expenditures
GDP  C  I  G  NX
G
Now, add net factor payments to both sides
GNP  C  I  G  CA
G
Current Account = NX + NFP
Lastly subtract depreciation and indirect taxes from both sides
NI  C  I  G  CA
N
National
Income
Net Investment (Gross Investment minus depreciation)
Consumer Outlays (Net of Indirect Taxes)
The flow of funds measures financial market transactions
NI  C  I  G  CA
N
National Income = Personal Income + Undistributed Corporate Profits
Subtract taxes from both sides….
NI  T  C  I  G  T   CA
N
Now, Subtract Consumption from both sides…
NI  T  C   S  I
N
 G  T   CA
Net Private Saving = Personal Saving + Undistributed Profits
Last year, the US current account was -$380B. What does
this mean?
N


NI  C  I  G  CA
Total US Outlays
Total US Income
Net lending abroad
In other words, the US is borrowing $1B per day from abroad! Should we be worried
about this?
S  I  G  T   CA
N
This number continues to grow as the US government overspends!!!
This number continues to shrink as US consumers
overspend!!
Think of the current account as the savings of the entire economy. We have
become a debtor nation!
1960-01-01
1970-01-01
1980-01-01
1990-01-01
2000-01-01
2010-01-01
100
0
-100
-300
-400
-500
-600
-700
-800
-900
Billions of Dollars
-200
What a wacky world we live in!
Currently, China is running a $30B trade
surplus with the world
SC  I C  GC  TC   CAC
Currently, the US is running a $380B trade
deficit with the world
SUS  IUS  GUS  TUS   CAUS
What’s wrong with this picture?
Principle #3: Is your variable in terms of current prices or fixed prices (Real vs.
Nominal)
Nominal Variables are in terms of a current year’s prices.
For example, you’re starting salary after college might be
$50,000 per year.
VS.
Real variables are in terms of some tangible commodity
or some constant year’s prices. Real variables measure
purchasing power.
How do we construct a measure of prices?
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
If beer increases in price to $4.50
(25% increase) and pizza
increases to $2.20 (10%
increase), this level of happiness
now costs
(2)($4.50) + (3)($2.20) = $15.60
ln 15.60   ln 13  *100  18%
Alternatively, we could write the price index in terms of relative dollars (relative
to a base year) instead of absolute dollars
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 =.54
Pizza Expenditure Share: (3)($2)/$13 = .46
 3.50 
 2.00 
PBY  .54  

.46




  1.0
 3.50 
 2.00 
(Or, 100)
 4.50 
 2.20 
PCY  .54  

.46




  1.2
3.50
2.00




(Or, 120)
ln 120   ln 100   *100  18%
The CPI is calculated by the Bureau of Labor Statistics (BLS) on a monthly basis
Personal Care
4%
Consumer
Price Index
Tobacco &
Smoking Products
1%
Food & Beverage
16%
Education &
Communication
5%
Housing
40%
Recreation
6%
The CPI is composed of
211 individual products
over 38 geographic areas.
Medical
6%
Transportation
17%
Apparel
5%
When calculating the CPI, be sure to use the same weights each year!
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
 200 
 90 
 40 
 30 
CPI1983  .40  
  .30     .20     .10     1
 200 
 90 
 40 
 30 
( or, 100 )
 780 
 280 
 190 
 245 
CPI 2013  .40  

.30

.20

.10












  4.25
 200 
 90 
 40 
 30 
(Or, 425)
 800 
 300 
 200 
 250 
CPI 2014  .40  

.30

.20

.10












  4.43
 200 
 90 
 40 
 30 
( or, 443 )
CPI inflation (2013 – 2014)
  ln  4.43  ln  4.25   *100  4.15%
Average CPI inflation
 ln  443  ln 100  

 *100  4.80%
31


The CPI is an example of a fixed weight index
The Consumer Price Index (1948 – 2014)
Average Inflation = 3.54%
CPI
CPI
CPI Inflation Rate
1983 = 100
Note That expenditure shares do change over time, so the weights need
to be updated periodically
Potential Problem:
Suppose at the current prices,
you elect to buy 3 slices of
pizza and two beers
$3.50
$2.00
The cost of your current happiness is (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%
Original Expenditure:
(2)($3.50) + (3)($2.00) = $13
Good
Base Year
Price (BY)
Current Year Price
(CY)
Inflation
Beer
$3.50
$4.50
25%
Pizza
$2
$2.20
10%
No Substitution:
Substitution:
(2)($4.50) + (3)($2.20) = $15.60
(1)($4.50) + (4)($2.20) = $13.30
ln 15.60   ln 13  *100  18%
ln 13.30   ln 13  *100  2.2%
Which measure of inflation is more realistic?
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
Inflation Rate
Chained CPI
CCPI
It is, however, very controversial…
Average Inflation Rate
Inflation Rate
CPI: 2.31%
CCPI: 2.06%
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)
CPI Inflation Rate (2.31% per year)
$12, 000  $12, 000 1.0231  $12, 000 1.0231  ...  $12, 000 1.0231  $212, 232
2
14
CCPI Inflation Rate (2.06% Per Year)
$12, 000  $12, 000 1.0206   $12, 000 1.0206   ...  $12, 000 1.0206   $208, 442
2
14
Difference = $3,790 (1.8%)
Now, consider that there are
approximately 65 million social security
recipients:
$3,790*65M = $246B
Another potential problem: Products change over time. Suppose you observe
the following TV Prices
2003
Price: $250
Features: 27 inch
Cathode Ray Tube
Enhanced Definition TV
S-Video Input
Universal Remote
 $1, 250  $250 

 *100  400%
$250


Note: The first plasma TV was released by Fijitsu 1n 1995. The 42’’ TV cost $14,999
2004
Price: $1,250
Features: 42 inch
Plasma
High Definition TV
S-Video Input
Universal Remote
Is this a fair
assessment of
inflation?
Solution: Hedonic price adjusting
What do we value in a TV? (At least,
what is reflected by price)
ln P  0  1 X1  2 X 2  ...   N X N  
Natural
log of
retail price
Television Features
What do we value in a TV? (At least, what is reflected by price)
Characteristic Category
Display Type
Features
Characteristic Name
Coefficient
Intercept
3.4455
Projection
-.25586
CRT
Base (0)
DLP
.58356
LCD Projection
.38566
LCD Direct View
.73075
Plasma
.72843
Screen Size
.08348
(Screen Size)^2
-.00049
Picture in Picture
.08430
Universal Remote
.16261
High Def (HDTV)
.34280
Extd Def (EDTV)
.12228
3D Comb. Filter
.07122
Flat Screen
.18461
S-Video Input
.13722
DVD Built in
.38247
Plasma TVs sell for 73%
more that CRT TVs
Each 1’’ increase in screen
size raises the price by 8%
HDTV is priced 22%
more than EDTV
First, value all the features on the old TV
Characteristic
Category
Display Type
Features
Total
Characteristic Name
Coefficient
Value
Intercept
3.4455
3.4455
Projection
-.25586
0
CRT
Base (0)
0
DLP
.58356
0
LCD Projection
.38566
0
LCD Direct View
.73075
0
Plasma
.72843
0
Screen Size
.08348
27*.08348
(Screen Size)^2
-.00049
27*27*(-.00049)
Picture in Picture
.08430
0
Universal Remote
.16261
.16261
High Def (HDTV)
.34280
0
Extd Def (EDTV)
.12228
.12228
3D Comb. Filter
.07122
0
Flat Screen
.18461
0
S-Video Input
.13722
.13722
DVD Built in
.38247
0
5.64208
Price: $250
Features: 27 inch
Cathode Ray Tube
Enhanced Definition TV
S-Video Input
Universal Remote
Now value all the features on a new TV
Characteristic
Category
Display Type
Features
Total
Characteristic Name
Coefficient
Value
Intercept
3.4455
3.4455
Projection
-.25586
0
CRT
Base (0)
0
DLP
.58356
0
LCD Projection
.38566
0
LCD Direct View
.73075
0
Plasma
.72843
.72843
Screen Size
.08348
42*.08348
(Screen Size)^2
-.00049
42*42*(-.00049)
Picture in Picture
.08430
0
Universal Remote
.16261
.16261
High Def (HDTV)
.34280
.34280
Extd Def (EDTV)
.12228
0
3D Comb. Filter
.07122
0
Flat Screen
.18461
0
S-Video Input
.13722
.13722
DVD Built in
.38247
0
7.45836
Price: $1,250
Features: 42 inch
Plasma
High Definition TV
S-Video Input
Universal Remote
Now, we can add the extra features to the old TV
P  $250e 7.458365.64208  $1,537
2003
2003
Price: $250
Features: 27 inch
Cathode Ray Tube
Enhanced Definition TV
S-Video Input
Universal Remote
 $1, 250  $1,537 
*100  18%


$1,573


Price: $1,537
Features: 42 inch
Plasma
High Definition TV
S-Video Input
Universal Remote
(Hedonically adjusted)
Potential Problem: What about housing? Consider
the following examples:
Option #1: Rent a
$240,000 house
$1,000/mo.
Option #2: Buy a
$240,000 house
with an interest only
mortgage (5% per
year)
$240,000(.05) = $12,000/yr.
= $1,000/mo.
Option #3: Buy a
$240,000 house
with a 30 year
mortgage (5% per
year)
$1,288/mo.
One of these things is not like the other!
Potential Problem: What about housing? Consider the following
examples
Option #3: Buy a
$240,000 house
with a 30 year
mortgage (5% per
year)
Option #1: Rent a
$240,000 house
OR
Option #2: Buy a
$240,000 house
with an interest only
mortgage (5% per
year)
$1,288/mo.
$1,000/mo.
Difference = $288/mo.
What if you put
$288/mo. and put it
in a savings account
that earns 5% per
year?
What if you put $288/mo. and put it in a savings
account that earns 5% per year?
5%/yr. = (5/12) = .41%/mo.
Month
Deposit
Beginning of Month
Balance
Interest
End of Month
Balance
1
$288
$288
($288)(.0041) = $1.18
$289.18
2
$288
$577.18
($577.18)(.0041) = $2.37
$579.55
3
$288
$867.55
($867.55)(.0041) = $3.56
$871.11
4
$288
$1,159.11
($1,159.11)(.0041) = $4.75
$1,163.86
5
$288
$1,451.86
($1,451.86)(.0041) = $5.95
$1,457.81
What do you think your
balance would be after
30 years?
Cool, huh!?
Potential Problem: What about housing? Consider the following
examples
Option #1: Rent a
$240,000 house
OR
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)
$1,000/mo.
(This is pure cost of living)
$1,288/mo.
(This is cost of living plus investment in an asset)
In 1983, the BLS decided to focus entirely on rental markets for housing.
Housing Prices
Housing Inflation
Average Inflation Rate
Home Price Index: 4.40%
Rental Index: 4.01%
Can you spot the housing
bubble?
An alternative to the consumer price index is the GDP Deflator.
Suppose we have the following Data
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
Now, Suppose we revalue current GDP at, say, prices in 2009 (Call this the base year)
Good
Production
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
We can use these two numbers to construct an implied relative
price
Current value of current
production (2014)
Base year value of current
production (Base year = 2009)
$410,000 (Current Dollars)
$360,000 (2009 Dollars)
$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)
Housing Share of Real GDP
 $150, 000 
 $360, 000   .41


Transp. Share of Real GDP
 $150, 000 
 $360, 000   .41


$360,000
Food Share of Real GDP
 $20, 000 
 $360, 000   .06


 $550 
 $350 
 $260 
 $220 
P  .41
  .41
  .06 
  .12 
  1.14
$500
$300
$200
$200








Apparel Share of Real GDP
 $40, 000 
 $360, 000   .12


(Or, 114)
Suppose we repeat for a different year to calculate an inflation rate
Good
Production (2013)
2009 Price
2013 Price
Housing
280
$500
$535
Transportation
490
$300
$310
Food
105
$200
$240
Apparel
170
$200
$216
Housing Share of Real GDP
Transp. Share of Real GDP
 $140, 000 
 $342, 000   .41


 $147, 000 
 $342, 000   .43


Food Share of Real GDP
 $21, 000 
 $342, 000   .06


 $535 
 $310 
 $240 
 $216 
P  .41

.41

.06

.12






  1.06
 $500 
 $300 
 $200 
 $200 
Index Inflation
ln 114   ln 106   *100  7.27%
Value of GDP at
2013 Prices
$363,620
$342,000
= 1.06 (or, 106)
Value of GDP at
2009 Prices
Apparel Share of Real GDP
 $34, 000 
 $342, 000   .10


(Or, 106)
Now, the inflation rate incorporates price changes as well as expenditure
share changes – a lot like the chained CPI!
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%
2013
Housing Share of Real GDP
 $140, 000 
 $342, 000   .41


Transp. Share of Real GDP
 $147, 000 
 $342, 000   .43


Food Share of Real GDP
 $21, 000 
 $342, 000   .06


Apparel Share of Real GDP
 $34, 000 
 $342, 000   .10


2014
Housing Share of Real GDP
 $150, 000 
 $360, 000   .41


Transp. Share of Real GDP
 $150, 000 
 $360, 000   .41


Food Share of Real GDP
 $20, 000 
 $360, 000   .06


Apparel Share of Real GDP
 $40, 000 
 $360, 000   .12


The GDP deflator is an example of a variable weight index
The GDP Deflator: 1948 - 2014
Average Inflation: 3.20%
Inflation Rate
GDP Deflator
GDP Def.
2009 = 100
Inflation with the GDP Deflator versus the CPI
Average Inflation
CPI: 3.55%
GDP Def.: 3.20%
Let’s enlarge this area
Inflation with the GDP Deflator versus the CPI
What’s going on here?
Average Inflation
CPI: 2.30%
GDP Deflator: 2.01%
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 plot out GDP over a few years. Notice the “saw tooth” pattern?
Retail sales follows a seasonal cycle with lows in January/February and
September/October and Highs in May/June and December. This
seasonality in sales creates seasonal cycles in most macro series.
Retail Sales (Seasonally Adjusted)
Ja
nM 01
ar
M 01
ay
-0
Ju 1
l -0
Se 1
p0
No 1
v0
Ja 1
nM 02
ar
M 02
ay
-0
Ju 2
l -0
Se 2
p0
No 2
v0
Ja 2
nM 03
ar
M 03
ay
-0
3
355000
335000
315000
295000
275000
255000
NSA
SA
Seasonally adjusting is a process that removes the seasonal components.
Gross Domestic Product
12500
12000
11500
11000
10500
GDP(NSA)
GDP(SA)
10000
9500
9000
In 2002(Q1), GDP is $10,064B while Seasonally adjusted GDP is
$10,333B
Lets take a look at the US economy from 1957 to 2008 …
GDP (Billions of Dollars)
16000.0
$14.2T
(2008Q1)
14000.0
12000.0
10000.0
8000.0
6000.0
4000.0
2000.0
$457.2B
(1957Q1)
0.0
Jan-57
Jan-67
Jan-77
Jan-87
LN 14,200  LN 457.2*100 / 51  6.73%
Jan-97
Jan-07
Comparing GDP in 1957 and 2008 is like comparing apples and oranges. Prices
were much different 51 years ago!!
Year
Price Level (CPI)
1957
30.0
1983
100.0
2000
180.0
2008
213.3
Let’s “scale up” GDP in 1957 and “scale down” GDP in 2008 to reflect year
2000 prices…
$457.2B
(1957Q1)
180
30
=$2,743.2B
Now, these numbers are
comparable!
$14,200B
(2008Q1)
180
213
=$11,983.12B
We have now converted GDP to real GDP (2000 prices)
GDP (Billions of 2000 Dollars)
16000.0
$14,200B
(2008Q1)
14000.0
12000.0
$11,983B
10000.0
8000.0
6000.0
4000.0
$2,743.2B
2000.0
$457.2B
(1957Q1)
0.0
Jan-57
Jan-67
Jan-77
Jan-87
Jan-97
Jan-07
Lets convert all the years…
We have now converted GDP to real GDP (2000 prices)
Real GDP (Billions of 2000 Dollars)
16000.0
$14,200B
(2008Q1)
14000.0
12000.0
$11,983B
10000.0
8000.0
6000.0
4000.0
$2,743.2B
2000.0
$457.2B
(1957Q1)
0.0
Jan-57
Jan-67
Jan-77
Jan-87
Jan-97
Jan-07
Note that “Real” GDP crosses GDP at the year 2000
Now that we have real GDP, let’s think about the trend…
Real GDP (Billions of 2000 Dollars)
14000.0
12000.0
$11,983B
10000.0
8000.0
6000.0
4000.0
$2,743B
2000.0
0.0
Jan-57
Jan-67
Jan-77
Jan-87
Jan-97
Jan-07
Would a linear trend fit this data (constant dollar growth in GDP)
Exponential growth is constant annual
Average quarterly growth rate
percentage growth
Real GDP (Billions of 2000 Dollars)
14000.0
$11,983B
12000.0
y = 2371.3e0.008x
10000.0
8000.0
6000.0
4000.0
$2,743B2000.0
0.0
1
13 25 37 49 61 73 85 97 109 121 133 145 157 169 181 193
LN 11,983  LN 2,743*100 / 51  2.89%
The previous slide uses an exponential trend. This assumes that the US has
some constant annual rate of real economic growth (3.2% per year). Note that
actual growth varies even over long time periods.
4.5
4
3.5
3
2.5
2
1.5
1
0.5
0
1957-1967 1967-1977 1977-1987 1987-1997 1997-2007 2007-2013
Notice the downward trend in growth…we’ll talk about that later!
Over five year periods, we see that growth seems to have a cyclical pattern
rather than a constant annual rate.
6
5
4
3
2
1
0
The Hodrick-Prescott (HP) filter allows us to calculate a trend rate of
growth that is not constant.
The HP filter applies a minimization problem…pretty ugly, huh?!
Squared deviations
between series and
trend
Smoothness of trend
Smoothing parameter
(bigger numbers create
smoother trends) – usual
value = 1600
Here we have annualized growth rates of the HP trend and the Exponential
trend
Why is getting the trend right so important?
Lets imagine enlarging a portion of our GDP graph with a trend. We can see a
distinct set of stages…
Trend
Growth
Trend
Negative growth
GDP
Time
Above trend growth
Below Trend Growth
This is what we mean by the business cycle
Removing the trend involves subtracting out the trend component from GDP
 GDPt   trend t 
% Dev  
*100

trend t 


GDP
Trend
Time
t
Removing the trend leaves us with the business cycle.
Recession
Expansion
2.00
Peak
1.50
0.50
2004-IV
2004-III
2004-II
2004-I
2003-IV
2003-III
2003-II
2003-I
2002-IV
2002-III
2002-II
2002-I
2001-IV
2001-III
2001-II
2001-I
2000-IV
2000-III
-0.50
2000-II
0.00
2000-I
% Deviation
1.00
-1.00
-1.50
-2.00
 Value  Trend 
% Deviation  
 *100
Trend


Trough
% Deviation from trend
Here, we are plotting percentage deviation of GDP from a HP trend
We have had 11 cycles since WWII
The US has had 13 Cycles since the great depression
Business Cycle Dates
Peak
Trough
Duration (In Months)
Contraction
Expansion
Cycle
(peak to trough)
(Previous trough to
this peak)
(Peak from
previous peak)
August 1929
March 1933
43
21
34
May 1937
June 1938
13
50
93
Feb 1945
Oct 1945
8
80
93
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
13
55
69
Average