FIN 30220: Macroeconomic Analysis

Using Economic Data

“There are three kinds of lies; Lies, Damn Lies, and Statistics”

- Mark Twain

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

Source: CIA Factbook

Lets see how we compare to other parts of the world…

But, How would you define poverty?

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)

Family Size Threshold

One $11,670

Two $15,730

Three $19,790

Four $23,850

Five $27,910

Six $31,970

Seven $36,030

Eight $40,090

Nine $44,150

2014 POVERTY GUIDELINES

USDA Food Plans: 1964

50$1014 1.05 $11,627

1014$3338$5250.6$ (Poverty Line in 1964)

(Approximate Poverty Line Today)

Food Budget as a percentage of household income: 1964

0 20 40 60

Under $3,000

$4,000 - $4,999

$6,000 - $6,999

$8,000 - $9,999

$12,000 - $14,999

$20,000 - $24,999

Average

Lower Income Households spent around 33% on Food in 1964

Food Budget as a percentage of household income: 2003

In Fact, No Family Spends Anything Near 33% on Food Today!!!

16.5%

Suppose we use current food prices and the current budget share

416,13$6236,2$236,2$5243$ (Poverty Line in 2014?)

Assuming Food is 16.5% of ones budget

1014$3338$5250.6$

Actual Calculation

Redefined Household Budget (Current food prices)

416,13$6236,2$236,2$5243$

So, which is it and why should we care?

50$1014 1.05 $11,627

15% Difference

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?

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

Country  

Absolute poverty rate(threshold set at 40% of U.S. median household income) 

Relative poverty rate (40% of Median Income)

Pre-transfer

Post-transfer Pre-transfer Post-transfer

Sweden 23.7 5.8 14.8 4.8

Norway 9.2 1.7 12.4 4.0

Netherlands 22.1 7.3 18.5 11.5

Finland 11.9 3.7 12.4 3.1

Denmark 26.4 5.9 17.4 4.8

Germany 15.2 4.3 9.7 5.1

Switzerland 12.5 3.8 10.9 9.1

Canada 22.5 6.5 17.1 11.9

France 36.1 9.8 21.8 6.1

Belgium 26.8 6.0 19.5 4.1

Australia 23.3 11.9 16.2 9.2

United Kingdom

16.8 8.7 16.4 8.2

United States 21.0 11.7 21.0 11.7

Italy 30.7 14.3 19.7 9.1

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!

The common international poverty line has in the past been roughly $1 a day. In 2008, the World Bank came out with a revised figure of $1.25.

Percentage of Population Living on Less that $1.25/day

*Source: United Nations

1991 Recession 2001 Recession

Principle #2: How is your variable measured?

Example: U.S. Unemployment

2007 Recession

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 (147 Million)

No

2) “Have you looked for a job in the past 30 days?”

YESYou are unemployed (9 Million)

No

You are not in the labor force (93 Million)

Unemployment Rate (UR)

= UnemployedLabor Force

=9

147+ 9= .057 (5.7%)

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(140 Million)

1) “Are you currently working?” (Note: no mention of part time or full time)

YESYou are employed (147 Million)

Wait a minute, that’s not what the household survey reported??? Which is it ???

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

-1,500

-1,000

-500

0

500

1,000

1,500

1990 1992 1994 1996 1998 2000 2002 2004

Revisions to Total Payroll EmploymentPreliminary minus Current Estimate, thousands

J obs overestimated

J obs underestimated

Source: Bureau of Labor Statistics

However, the establishment survey is subject to fairly large revisions

Pay Period Pay Period

Job at Company A

count = 1 payroll job count = 2 payroll jobs

Job at Company B

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!!

In months with high job turnover, the establishment survey will overstate employment.

No Turnover Turnover

7.71M jobs arelost per quarter

8.11M jobs are gained per quarter

Average US Labor Market Turnover

FYI: Worst-case estimates predict outsourcing costs us 55,000 jobs per quarter.

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.

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

Example: The Top 10 All Time Grossing Films (in Millions – US)

1) Avatar (2009): $760

2) Titanic(1997): $658

3) Marvel’s the Avengers (2012): $588

4) The Dark Knight (2008): $533

5) Star Wars I: The Phantom Menace (1999) $474

6) Star Wars IV: A New Hope (1977): $460

7) The Dark Knight Rises (2012) $449

8) Shrek 2 (2011): $441

9) E.T. The Extra-Terrestrial (1982): $435

10) The Hunger Games: Catching Fire (2013): $424

Principle #3: Is your variable in terms of current prices or fixed prices (Real vs. Nominal)

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.

Real Income = Nominal Income

Price = $50,000$2.00

= 25,000

In 2009, a gallon of gas cost $3.50

Real Gross = Nominal Gross

Price = $749M$3.50 = 214M

Real Income = Nominal Gross

Price = $460M

$.62= 742M

In 1977, a gallon of gas cost $.62

(Gallons of Gas)

(Gallons of Gas)

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)

Real X = Target year PriceCurrent Year Price

Nominal X

Real Gross

= $270M

$1.26$3.50$749M=

Real Gross

= $935M

$1.26$.62$460M=

( 1997 Dollars) ( 1997 Dollars)

Current Year

Target Year

These two dollar figures are comparable because they represent the same year’s dollars!

The Top 10 All Time Grossing Films– Inflation Adjusted (Millions of 2000 Dollars)

1) Gone With the Wind (1939): $1,689

2) Star Wars Episode IV(1977): $960

3) The Sound of Music(1965): $768

4) ET: The Extraterrestrial(1982): $764

5) The Ten Commandments (1956): $706

6) Titanic (1997): $691

7) Jaws (1975): $690

8) Dr. Zhivago (1965): $669

9) The Exorcist (1973): $596

10) Snow White (1937): $587

Notes: Avatar falls to #14 ($516), a movie ticket in 1939 was $0.23

Suppose that you buy a $1,000, 90 Day Treasury Bill for $994

90 Days from now, you receive $1,000 from the government

$1,000 - $994$994

X 100 = .6%

Alternatively, you could buy a $1,000, 5 year bond for $902

5 years from now, you receive $1,000 from the government

$1,000 - $902$902

X 100 =10.86%

Which of these two assets is paying a higher return?

Principle #4: Annualizing

Example: Treasury Yields

$1 $1.006 $1.012 $1.018 $1.024

$1(1.006) $1(1.006) $1(1.006) $1(1.006)

Suppose that you could earn .6% interest every quarter (90 days). How much would you have in a year?

2 3 4

You earned 2.4% (Annualized)

$1 $?? $?? $?? $??

$1(1+i) $1(1+i) $1(1+i) $1(1+i)

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)?

2 3 4

$1.1086

$1(1+i)5

You earned 2.0% (Annualized) 02.11086.111086.11 5

15 ii

GDP

Time

Principle #5: Economic data can be can be broken into 3 components:

Trend (many years)Business Cycle (1-5 years)Seasonal (Months)

Trend

Seasonal Cycle

Business Cycle

Recessions are periods of below trend growth

Expansions are periods of above trend growth

Example: Tax Cuts, Tax Revenues and “VooDoo Economics”

Bracket Old Rate New Rate

$0 - $6,000 15% 10%

$6,000 - $27,250 15% 15%

$27,251 - $67,550 28% 25%

$67,551 - $141,600 31% 28%

$141,601 - $307,300 36% 33%

$307,301 + 39.6% 35%

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”

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.

If the government cuts the tax rate to 10%, then the Griffin’s tax bill falls to $5,000

The cost of the tax cut is the $5,000 in lost revenues

What do we mean by the “cost” of a tax cut, anyways?

By this measure, the Bush Tax cuts have a price tag of around $130 Billion per year!!

Source: Congressional Budget Office

Let’s take a look at previous marginal tax rate changes to put the Bush tax cut in a historical context.

Wilson1917

Coolidge1925

FDR1933

Kennedy1964

Reagan1981

Bush2001/2003

Tax Bill Cost in Dollars (Billions)

Kennedy Tax Cut (1964) $11.5

Reagan Tax Cut (1981) $38.3

Bush Tax Cut (2001) $73.8

Bush Tax Cut (2003) $60.8

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?

Kennedy1964

Reagan1981

Bush2001/2003

Cost (in 1964 dollars): $11.5BCPI: 30.9Real GDP: $2998.6B

Cost (in 1981 dollars): $38.3BCPI: 87.0Real GDP: $5,291.7B

Cost (in 2003 dollars): $134.6BCPI: 175.1Real GDP: $10,301B

175.130.9$11.5B

175.187.0$38.3B

175.1175.1$134.6B

= $67.6B

= $79.9B

=$134.65B

(2.25% of GDP)

(1.5% of GDP)

(1.3% of GDP)

When expressed in real terms as a percentage of GDP, the Bush tax cuts aren’t so big after all!

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?

Tax Rate

Tax Revenues

0% 100%Revenue Maximizing Rate

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.

Is there evidence of a Laffer curve in practice?

Annual Federal Receipts (Billions)

Year 0 Year 1 Year 2 Year 3 Year 4

Kennedy (1964) $116.8 $130.8 $148.8 $153.0 $186.9

Reagan (1981) $617.7 $600.5 $666.5 $734.0 $769.2

Bush (2001) $1,853.4 $1,782.5 $1,880.2 $2,153.8 $2,402.7

Tax Rate

Tax Revenues

0% 100%Revenue Maximizing Rate

History suggests that taxes are two high, but be careful…

Source: Congressional Budget Office

Date Revenues (Billions of Dollars)

% Change CPI Real Revenues (Billions of 2003 Dollars)

%Change

1964 116.8 --- 30.9 720.8 ---

1965 130.8 11.3 31.2 799.4 10.3

1966 148.8 24.2 31.8 892.3 21.3

1967 153 27.0 32.9 886.8 20.7

1968 186.9 47.0 34.1 1045.2 37.2

1981 617.7 --- 87.0 1353.9 ---

1982 600.5 -2.82 94.3 1214.3 -10.9

1983 666.5 7.6 97.8 1299.6 -4.10

1984 734 17.25 101.9 1373.6 1.4

1985 769.2 21.9 105.5 1390.4 2.6

2001 1853.4 --- 175.1 2018.5 ---

2002 1782.5 -3.90 177.1 1919.4 -5.0

2003 1880.2 1.44 181.7 1973.3 -2.3

2004 2153.8 15.0 185.2 2217.7 9.4

2005 2402.7 25.9 190.7 2402.7 17.4

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

After correcting for price changes, it appears that empirical evidence suggests the presence of a Laffer curve. However, we need to be careful.

*Source: Congressional Budget Office

Kennedy1964

Reagan1981

Bush2001/2003

Recession

Expansion

Each of these tax cuts was passed during a recession!

The Laffer effect of a tax cut should affect the trend, but not the cycle…

GDP

Time

Old Tax Code

New Tax Code

This is what we have measured

This is what we should be measuring

In other words, we have overstated the Laffer effect in the previous slides