Macroeconomics Mini-course

Professor Pierre Yared

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Questions

• What is GDP?

• What drives economic growth?

• What drives investment?

• What drives inflation and exchange rates?

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Questions

What is GDP?

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4Share of world production, 2002, using current exchange rates

World GDP

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GDP Definition

Gross Domestic Product (GDP)

The market value of final goods and services newly produced within a fixed period of time, within the geographic boundaries of a country

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Three Equivalent Ways of Measuring GDP

• Production Approach

• Inputs (capital and labor) generate output

• Value added by individual firms

• Sectoral data (e.g., agriculture, manufacturing, services)

• Income Approach

• Payments made to inputs into production

• Wages to workers and rental rate to owners of capital

• Expenditure Approach

• Components: Consumption, investment, public spending, net exports

• Most important and common way of measuring GDP

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GDP by Expenditure: International Comparisons, 2007

C, 70%

I, 15%

NX, -5%

G, 19%

C, 47%

I, 18%

G, 26%

NX, 8%

C, 63%

I, 15%

G, 20%

NX, 2%

US

China Brazil

Sweden

C, 36%

I, 43%

G, 13%

NX, 9%

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Questions

What drives economic growth?

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US Growth Experience

Argentina

Australia

Brazil

China

Mexico

US

Canada

U.KGermany

India

Japan

Nigeria$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

1860 1880 1900 1920 1940 1960 1980 2000 2020

Real GDP per capita

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How Do We Make Sense of Different Growth Experiences?

0

1000

2000

3000

4000

5000

6000

1965 1970 1975 1980 1985 1990 1995 2000 2005

Year

Real GDP per Capita in 1996 Chain weighted $ (PWT)

China

Congo, Dem. Rep.

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Production Over Many Years

Even More Capital

New Labor

Production

Consumption + Public Spending + Net Exports Investment

Capital

Labor

NewProduction

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Three Ways of Increasing GDP per Capita

• Capital per worker• More machines per worker raises output per person

• Increases if investment is rising faster than the size of the work force

• Participation rate• A higher fraction of population in workforce raises output per person

• Major increases have occurred through women’s liberation

• Total factor productivity (TFP)• Corresponds to production process (black box) in flow diagram

• Implication: Same inputs can produce different outputs

• Most important determinant of cross-country income differences

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Latin America Has Not Caught Up: Why?

Y/Pop = N/Pop A (K/N)0.3

1950

Latin America 3,100 .34

US 11,100 .40

Latin America / US .28 .85 .49 (.27).3 = .68

2000

Latin America 7,400 .35

US 33,400 .48

Latin America / US .22 .73 .42 (.32).3 = .71

Based on data and analysis in Cole, Ohanian, Riascos, Schmitz (2005)

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What is Behind Total Factor Productivity?

• Education• Important for workers to have skills and abilities to be productive

• Important to accumulate these over time through schooling

• Geography• Important to develop effective agriculture to start growth

• Important to have low disease and a healthy workforce

• Important to have access to trade to adopt technology

• Institutions• Important to prevent expropriation of investment by government

• Important to enforce legal contracts among parties

• Important to have low policy volatility and stable business environment

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Questions

What drives investment?

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Investment is Financed by Savings

Private Savings

+

Public Savings

+

International Savings

=

Investment

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Three Sources of Savings

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• Private Savings

• Households can set aside resources or borrow them

• Businesses can also borrow or lend

• Public Savings

• Governments can set aside resources or borrow them

• Government deficit is negative of public savings• i.e., Public spending minus revenues

• Private Savings + Public Savings = National Savings

• International Savings

• Neighbors can set aside resources or borrow them

• Current account deficit is international savings

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-5%

0%

5%

10%

15%

20%

25%

50 55 60 65 70 75 80 85 90 95 00 05

Saving Identity in the US (% of GDP)

Investment

Private Savings

Government Savings

International

Savings

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Questions

What drives inflation and exchange rates?

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US Inflation

Inflationy-o-y% change in CPI

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07

Date

percent

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China Inflation

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Argentina Hyperinflation

Monthly Inflation in Argentina

-1.0

9.0

19.0

29.0

39.0

49.0

Jan-70Jan-73Jan-76Jan-79Jan-82Jan-85Jan-88Jan-91Jan-94Jan-97Jan-00Jan-03Jan-06

Montly Percent Change (non-annualized)

July 89: 197% March 90: 96%

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Determinants of Inflation

• Inflation is measured as the rate of change of the price level

• Various measures: CPI, GDP deflator, CPE

• Headline inflation: aggregates all prices

• Core inflation: Excludes food and energy and is less volatile

• What determines long run inflation? Money growth

• Also applies to hyperinflation at shorter frequencies

• Why do governments allow hyperinflation?: Seignorage

• Inflation is a form of indirect taxation on holders of money

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Determinants of Exchange Rates

• Long run: Inflation differences affect exchange rate

• Currency experiencing more inflation is also depreciating

• Implication: Can fight hyperinflation by fixing exchange rate

• Medium run: International trade competition affect exchange rates

• Tendency for real price of goods to equalize through competition

• Cheaper goods from one country cause its currency to appreciate

• If central bank fixes exchange rate, nominal price of goods will rise

• Short run: Interest rate movements affect exchange rates

• Increase in interest rate in one country causes its currency to rise

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Summary of Questions Answered

• What is GDP?

• What drives economic growth?

• What drives investment?

• What drives inflation and exchange rates?

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