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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
Expenses 26,000,000
Wages 20,000,000
Cost of Intermediate
Inputs (Parts) 6,000,000
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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
Expenses 26,000,000
Wages 20,000,000
Paid to US workers 18,000,000
Paid to Japanese managers 2,000,000
Cost of Int. Inputs(Parts) 6,000,000
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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
i NFA = Net factor income from abroad = interest rate times net
foreign assets.
GNP = GDP + i NFA = GDP + Net factor income from abroad
Accounting Identities
Sales revenue 40,000,000
Expenses 32,000,000
Wages 20,000,000
Cost of Parts 6,000,000
Interest 2,000,000
Depreciation of capital 4,000,000
% Share of GDP
GDP 6931.4 100%
Consumption 4698.7 67.8%
Durable Goods 580.9
Non-Durable Goods 1429.7
Services 2688.1
Gross Private Domestic Investment 1014.4 14.6%
Non Residential 667.2
Residential 287.7
Change in Bus. Inventories 59.5
Government Consumption 1314.7 18.9%
Net Exports of Goods and Services -96.4 -1.3%
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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
GNP 6922.4
GDP + M = C + I + G + X
GNPt = GDPt + it NFAt = Ct + It + Gt + (NXt + it NFAt )=
= Ct + It + Gt + CAt
CAt = NX t + it NFAt
Current Account = Trade Balance + Net Factor Income from abroad
CA = - $ 5.3b
i NFA = -$ 13.6b
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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
CA = GNP - (C + G + I)
(C +G +I) is "absorption" (domestic spending for consumption and investment purposes)
Similarly, the current account in the year 1997 is equal to the difference in the stock of net
foreign assets of the country between the end of 1997 and the end of 1996. A CA surplus
results in an increase in the net foreign assets of a country while a CA deficit results in a
decrease of these assets or, if the country is already a net debtor, it results in an increase in
the net foreign debt of the country.
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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
A current account surplus (flow) results in an increase in the net foreign assets of a country
(change in stocks). In fact, the net foreign assets at the beginning of next period (t+1) must be
equal to those in period t plus total national income (GNP) minus the part of national income
that is consumed (C and G) or invested (I):
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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
Stg = - Deft = Tt - G t
INTERPRETATION OF (3)
A current account deficit may be caused by:
1. An increase in national investment
2. A fall in national savings; specifically:
2a. A fall in private savings and/or
2b. An increase in budget deficits (a fall in public savings).
1. Current account deficits caused by a boom in investment are usually
good and sustainable.
Forms of the capital inflow:
1. The country/firms could directly borrow from foreign banks;
2. The domestic firms could borrow from domestic banks but these in turn borrow from
foreign banks;
3. The country/firms could issue new bonds that are bought by foreign investors;
4. The country/firms can issue new equity that is purchased by foreign investors.
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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
5. If the new investment is made by a foreign firm that decides to build a new plant in the
domestic economy, the flow of foreign capital that finances this investment project is called
Foreign Direct Investment (FDI).
Two caveats:
a. It may be dangerous to run a current account deficit (and borrow from
abroad) to finance excessive investments in non-traded sectors of the
economy (such as real estate).
b. Governments in Asia gave incentives (subsidies) to firms to invest too
much and incentives to the domestic banks (promises of bail-out) to
borrow too much from abroad to finance dubious investment projects by
the firms.
Banks borrowed too much from abroad for many reasons, mostly related to the implicit
promise of a government bail-out in case things went wrong:
1. Their risk capital was usually small and owners of banks risked relatively little if the banks
went bankrupt ("moral hazard" problem);
2. Several banks were public or controlled indirectly by the government that was directing
credit to politically favored firms, sectors and investment projects;
3. Depositors of the banks were offered implicit or explicit deposit insurance and therefore
did not monitor the lending decisions of banks;
4. The banks themselves were given implicit guarantees of a government bail-out if their
financial conditions went sour because of excessive foreign borrowing;
5. International banks lent vast sums of money to the domestic Asian banks because they
knew that governments would bail-out the domestic banks if things went wrong;
1. Banks borrowed too much from abroad and lent too much to domestic firms;
2. Because of all the implicit public guarantees of bail-out, the interest rate at which domestic
banks could borrow abroad and lend at home was low (relative to the riskiness of the projects
being financed) so that domestic firms invested too much in projects that were marginal if not
outright not profitable.
Once these investment projects turned out not to be profitable, the firms (and the banks that
lent them large sum) found themselves with a huge amount of foreign debt (mostly in foreign
currencies) that could not be repaid. The exchange rate crisis that ensued made things only
worse as the currency depreciation dramatically increased real burden in domestic currencies
of the debt that was denominated in foreign currencies.
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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
10 of 21 7.12.2010 22:56 ч.
Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
MEASURING GDP
2. IN DECEMBER 1996, THE BOSKIN COMMISSION REACHED
THE CONCLUSION THAT THE CPI OVERESTIMATES THE
INFLATION RATE BY 1% TO 2% PER YEAR
Home Page on the recent controversies on the correct measurement of
GDP and inflation.
Nominal GDP Real GDP
1987 4539.9 4539.9
1992 6020.2 4979.3
1993 6343.3 5134.5
The growth rate of nominal GDP in 1993:
5.3% = 100 x (6343.3 - 6020.2)/6020.2
"Fixed-weight" method: measure quantities of goods in different years
at the prices prevailing in a base year (1987).
The growth rate of real GDP in 1993:
3.1% = 100 x (5134.5 - 4979.3)/4979.3
2.2 percent (5.3%-3.1%) of the growth in current dollar GDP was
simply inflation (a general increase in dollar prices of goods).
A measure of the average price is the ratio of GDP in current prices to
GDP in 1987 prices: the GDP implicit price deflator.
GDP Price Deflator = GDP in current prices (Nominal GDP) / GDP in
base year prices (Real GDP)
Nominal GDP (NY) = Real GDP (Y) x GDP deflator (P)
NYt = Yt x Pt
1987 100
1992 120.9 = 100 x 6020.2/4979.3
1993 123.5 = 100 x 6343.3/5134.5
1993 inflation rate of 2.2 percent (= 123.5/120.9 -1).
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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
The inflation rate p is the % rate of change of the price level (the GDP
deflator) between period t-1 and period t, or:
pt = (P t - Pt-1)/P t-1 = inflation rate in year t.
The rate of growth of nominal GDP (nyt) is equal to the rate of growth
of real GDP (yt ) plus the rate of inflation (pt):
(ny)t = (NYt - NYt-1)/NYt-1 = (NYt / NYt-1) -1
= (Yt x Pt) / (Yt-1 x Pt-1) - 1 = (Yt / Yt-1) x (Pt / Pt-1) - 1
ny = ( 1 + y) x (1 + p) - 1 = y + p + yp (*)
Since yp is a small number, the expression (*) is approximately equal to:
Conceptual problem: it's not clear how to measure the purchasing power of the dollar when
the dollar prices of different goods are changing at different rates.
Note: the relative price of chips to fish has fallen from 2 (=.50/.25) to 1.5 (=.75/.50).
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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
GDP deflator (the ratio of current price GDP to GDP in base year prices):
Real GDP growth measured with fixed weights: 6.66% = 100 x (8-7.5)/7.5
(1 + ny) = ( 1 + y) x (1 + p)
Difference between the two indexes: the CPI uses date 1 quantities while the GDP deflator
uses date 2 quantities to compute the date 2 price index. (Check out the CPI Calculation
Machine).
Since nominal GDP growth is again 73.3% and the fixed-basket (CPI based) measure of
inflation is 66.6%, now the fixed basket measure of real GDP is 4% rather than the higher
6.66% obtained by using the fixed-weight method.
How can we compute directly the real GDP growth if we use the CPI deflator ?
Compute real GDP in the second period by taking period 2 as the base year (rather than
period 1 as in the fixed-weight method).
Period 1 Real GDP using date 2 as the base year: 12.5 =0.75x10+0.5x10
Implied Real (fixed-basket) GDP growth using period 2 as base year: 4% =(100 x
(13-12.5)/12.5)
Note: depending on which deflator we use, our estimate of real GDP growth will be different
(6.66% versus 4%).
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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
There is no unique or best way to separate relative price movements from general
movements in the price level, even in theory.
The movements in different prices indexes are similar. See the graphs of the CPI and GDP
deflator in levels and rates of change (Figure 8 and Figure 9).
Note: the fixed-weight method used by the US until 1995 had the disadvantage that it was
giving too much weight in the calculation of real GDP to the good whose relative price had
fallen over time (in this example and reality chips and computers).
Date 2 0.5 20 2 5
Intuitively: in this example real GDP has not changed in period 2 relative to period 1.
Fixed-weight approach:
In fixed-weight approach, too much weight is given to production of the good (chip) whose
price has fallen over time: so, the estimate of the output level and its growth rate is biased
upward (25% real growth).
It is like computing the real output of a PC computers in 1997 by taking the 1987 price of an
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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
equivalent machine (approximately $6,000) as the base for valuing the real value added of a
PC that is priced only at $2,000 today.
When the U.S. relied on the fixed-weight method, it was giving too much weight in the
calculation of real GDP to the goods whose relative price had fallen over time (computers,
semiconductors and other high tech sectors of the economy).
Because of this bias, the value of the real output of computers was overestimated and led to
an overestimation of the growth rate of the economy. This issue became serious over the
1980's as the price of computers was falling.
In order to eliminate such a bias, the Department of Commerce switched at the end of
1995 to a chain-weight method of measuring real GDP.
Chain weight method: it is a combination of the fixed-weight method and the fixed-
basket method.
Real GDP is estimated twice, first using the previous year prices as the base (fixed-weight)
and the second time using the current year prices as the base and the previous year quantities
to compute real GDP in the previous year. Then, an average of the two is taken. Using this
method:
There are however several potential problems also with the chain-weight method:
1. Quality changes are not correctly measured (examples: computers, light) leading to under-
estimate of the product of industries where such quality changes occur.
Other issue: the CPI inflation rate also tends to overestimate the true level of inflation rate in
the US economy because of a number of biases.
In December 1996, the Boskin Commission reached the conclusion that the CPI overstates
the true inflation rate by 1% to 2% per year.
Note: if inflation is overestimated, then our measure of real GDP growth is underestimated as
well, as more of the growth of nominal GDP is imputed to an increase in prices rather than to
an increase in quantities produced.
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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
Table 1
Saving and Investment Rates for Developed Countries.
Entries are percentages, averages of quarterly data over the period 1970:1 to 1989:4.
Country S/Y I/Y CA/Y Y Growth
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17 of 21 7.12.2010 22:56 ч.
Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
FIGURE 4
FIGURE 4'
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Figure 6
Nominal and Real GDP
Figure 7
Nominal and Real Growth Rate of GDP
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Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
20 of 21 7.12.2010 22:56 ч.
Handout 1: Monitoring Macroeconomic Performance http://pages.stern.nyu.edu/~nroubini/NOTES/HAND1.HTM
Copyright: Nouriel Roubini, Stern School of Business, New York University, 1998.
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