Figure 2: International Comparison (US , Japan, Argentina)
Figure 3: International Comparison (US , China, Korea)
LEVEL AND GROWTH RATE OF GDP
Figure 4: "year-on-year'' growth rate of US GDP in quarterly data
(GDPt - GDPt-4) /GDPt-4
where GDPt is GDP in quarter t and GDPt-4 isGDP four quarters before.
NINE DOWNWARD SPIKES: RECESSIONS (DEFINED AS 2 CONSECUTIVE QUARTERS OF DECLINING GDP)
The National Bureau of Economic Research is the de facto arbiter of business cycles in the US.
Figure 4': Alternative way to define the growth rate of the economy (used by the US Government). Measure the growth rate of GDP in a particular quarter relative to the previous quarter and annualize such quarterly rate of growth by multiplying by four (quarterly growth rate of the economy at an annual rate (AR)):
4 x [(GDPt - GDPt-1) /GDPt-1 ]
To create quick charts of macro variables using these
alternative definitions, see the Economic
Chart Dispenser on the Web.
A table
with the most recent GDP data is available from the Bureau
of Economic Analysis at the Department of Commerce.
Figure 5: Growth rates of real GNP (total, not per capita) in Germany and Japan.
GDP (Gross Domestic Product): total production of goods and services of the US economy.
Sales revenue 40,000,000 Expenses 26,000,000 Wages 20,000,000 Cost of Intermediate Inputs (Parts) 6,000,000 Net Income 14,000,000FIRM'S CONTRIBUTION TO THE US ECONOMY = VALUE ADDED = SALES - COST OF INTERMEDIATE INPUTS = 40m - 6m = 34m
OTHER WAY TO COMPUTE VALUE ADDED = SUM OF PAYMENTS TO LABOR AND CAPITAL
VALUE-ADDED = FACTOR PAYMENTS = 20m+14m=34m
GDP = VALUE-ADDED PRODUCED BY FIRMS OPERATING IN THE US
GNP = VALUE-ADDED GENERATED BY "FACTOR INPUTS", CAPITAL AND LABOR, OWNED BY AMERICANS.
Example: An American working in London for Salomon Brothers would count in US GNP but not US GDP. She would also count in British GDP, since she's working there. EXAMPLE:
Sales revenue 40,000,000 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 Net Income 14,000,000 Paid to American owners 9,000,000 Paid to Japanese owners 5,000,000GDP = 34m = 40m - 6m = 20m + 14m
GNP = GDP - 2m - 5m = 27m = 18m + 9m
GNP = GDP - factors payments to foreigners (dividends, interest, rent to foreign residents owning assets in the US and wages of foreign residents working in the US) + factor payments from abroad to US residents (dividends, interest, rent to US residents owning assets abroad and wages of Americans working abroad).
Difference between GDP and GNP not very large in the U.S but can be large for other countries. Examples (1987 data):
GDP + Net Factor = GNP % Difference Income(+) between the two Payments(-) from abroad
US 4540 4 4544 0.08% Mexico 192 -9 183 -4.9% Ireland 19.9 -1.9 18 -10%The Net Foreign Assets (NFA) of a country (say the U.S):
NFA = Net Foreign Assets = Assets owned by Americans abroad - Liabilities of Americans towards foreigners
Assets (and liabilities) include stocks, bonds, loans from banks and other sources, real estate, firm ownership and so on.
If NFA > 0, the country is a creditor country.
If NFA < 0, the country is a debtor country.
i = average interest rate (rate of return) on net foreign assets (foreign assets - foreign liabilities)
i NFA = Net factor income from abroad = interest rate times net foreign assets.
GNP = GDP + i NFA = GDP + Net factor income
from abroad
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 Net Income 8,000,000Net Domestic Product = GDP - Depreciation = 34m-4m= 30m
1994 US data for factor payments (in billions of dollars):
1. National Income 5,495.1 2. Compensation of employees 4,008.3 3. Proprietor's income 450.9 4. Corporate Profits 526.2 5. Rents 116.6 6. Net Interest 392.8Second way to look at GDP: who purchases the final goods.
GDP = consumer expenditures + investment + government purchases of goods and services + net exports
GDP = C + I + G + NX = C + I + G + (X - M).
.
1994
US data in Tables published in the Economic Report of the President.
.
% 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% Exports 722.0 10.5% Imports 818.4 11.8% ............................................. Net Factor Incomes from abroad -9.0 GNP 6922.4
Importance
of investment in Business Inventories to explain the business cycle (recessions)
: When aggregate demand falls (as when there is an exogenous
fall in consumption and investment, i.e. capital spending), firms at first
do not cut production but increase their inventories of goods (change in
inventories = production minus sales/demand); but if the fall in demand
is sustained they start to cut production to desired ratio of the
stock of inventories to sales; this fall in production reduces incomes
(as workers are laid off) and leads to further fall in consumption and
investment. Thus demand falls even further leading to further reductions
in output. This is the typical dynamics of the onset of a recession.
GDP + M = C + I + G + X
GNPt = GDPt + it NFAt = Ct + It + Gt + (NXt + it NFAt )=
= Ct + It + Gt + CAt
CAt = NXt + it NFAt
Current Account = Trade Balance + Net Factor Income
from abroad
Difference between NX and CA can be large if a country is a large creditor or debtor. Example: Brazil in 1986.
NX = + $ 8.3b
CA = - $ 5.3b
i NFA = -$ 13.6b
Current Account Balance (% of GDP)
1990 1991 1992 1993
1994 1995 1996
Korea
-1.24 -3.16 -1.70 -0.16
-1.45 -1.91 -4.89
Indonesia -4.40
-4.40 -2.46 -0.82 -1.54
-4.25 -3.41
Malaysia -2.27
-9.08 -4.06 -10.11 -11.51 -13.45
-5.99
Philippines -6.30
-2.46 -3.17 -6.69 -3.74
-5.06 -5.86
Singapore
9.45 12.36 12.38 8.48
18.12 17.93 16.26
Thailand
-8.74 -8.61 -6.28 -6.50
-7.16 -9.00 -9.18
Hong Kong 8.40
6.58 5.26 8.14 1.98
-2.21 0.58
China
3.02 3.07 1.09 -2.17
1.17 1.02 -0.34
Taiwan
3.70 4.10
CA = GNP - (C + G + I)
(C +G +I) is "absorption" (domestic spending for consumption and investment purposes)
S = GNP - C - G S: National Savings
CA = S - I
Similarity between a country and an individual
Insight in the Asian economic crisis:
If a country runs a current account deficit (a flow) the country is borrowing from the rest of the world and its foreign debt (a stock) will increase over time.
FLOWS AND STOCKS
A stock is measured at a particular point in time such as the stock of capital at the end of 1996.
A flow represents the change in the stock over a particular period of time: for example net investment in capital in the year 1997 is equal to the difference between the stock of capital between the end of 1997 and the end of 1996.
Kt+1 = Kt + It - Depreciationt
Stock of K at time t+1 = Stock of K at time t
+ (Net Investment in new capital in period t)
It - Depreciationt = Kt+1
- Kt
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.
NFAt+1 - NFAt = CAt
Similarity between a country and an individual
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):
NFAt+1 = NFAt + GDPt + it NFAt - Ct - Gt - It =
NFAt+1 = NFAt + CAt = NFAt + NXt + it NFAt
A CA > 0 leads to a larger NFA (larger net assets or smaller net liabilities).
A CA< 0 leads to a lower NFA.
A persistent current account deficit (CA<0) lead a creditor country to become a debtor country (NFA<0)
Example: the US is the largest debtor country in the world (-$1,900b in 2001) because of a long period of CA<0. Chart
During the 1990s, all the Asian countries that went into
a crisis in 1997 run very large and increasing current account deficits;
this led to a large accumulation of foreign debt that eventually became
unsustainable.
What Causes Current Account Deficits? Are Such Deficits
Bad?
Are They Unsustainable (i.e. Do They Necessarily Lead
to a Currency and Debt Crisis)?
(GNPt -Tt -Ct ) = It + (Gt -Tt ) + CAt ,
GNPt - Tt - Ct = Stp= Private Savings
Tt are taxes collected by the government (TXt ) net of transfer payments (TRt) and interest payments on the public debt (it Debtt ):
Tt = TXt - TR t - it Debtt
G - T = government budget deficit
GNP-T = disposable income of households
GNP-T-C = the amount of income households do not spend on goods and services, namely private saving Sp.
Sg = public (government savings) are the difference between government revenues and spending
Deft = (Gt - Tt ) = Gt - TXt + TRt + it Debtt = - Stg
Stg = - Deft = Tt
- Gt
[Debtt+1 = Debtt+ Gt - Tt = Debtt+ (Gt + TRt - TXt) + it Debtt]
Stp = It+ Deft + CAt (1)
St = Stp - Deft = Stp+ Stg = It + CAt
St = It + CAt (2)
CAt = St - It
=
Stp
-
Deft - It (3)
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.
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;
Outcome of all this:
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.
.
.
.
2. A current account deficit caused by a fall in national savings: a fall in private savings or an increase in budget deficits (a fall in public savings)
2.a. Current account deficits caused by large budget deficits are dangerous and eventually unsustainable (1980s Debt Crisis)
2.b. Current account deficits caused by falls in private savings may or may not be dangerous.
- Consumption boom in face of high expected future income
- Role of financial liberalization in consumption boom
Other factors affecting the sustainability of a large current account deficit:
1. the country's growth rate;
2. the composition of the current account deficit;
3. the degree of openness of the economy;
4. the size of the current account deficit (relative
to GDP).
HIGH CORRELATION BETWEEN BUDGET DEFICITS AND TRADE DEFICITS
RELATION BETWEEN SAVINGS RATE AND GROWTH (Table 1): INTERNATIONAL COMPARISON
CURRENT DEBATE IN THE US ON THE RIGHT MEASURE OF INFLATION AND THE RIGHT MEASURE OF GDP:
1. CONTROVERSIAL SWITCH IN DECEMBER 1995 FROM A FIXED-WEIGHT TO A CHAIN-WEIGHT METHOD OF 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 |
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 |
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 = (Pt - Pt-1)/Pt-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:
nyt = yt + pt = 5.3 = 3.1 + 2.2
(NYt - NYt-1)/NYt-1 = (Yt - Yt-1)/Yt-1 + (Pt - Pt-1)/Pt-1
Figure 6: Levels of nominal and real GDP for the U.S. economy (1992 base year).
Figure 7: Rate of growth of nominal and real GDP for the U.S.
ALTERNATIVE PRICE INDEX (DEFLATOR): CPI = CONSUMER PRICE INDEX: It measures the dollar price of a fixed "basket'' of goods.
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.
Example (made-up numbers).
| Price of Chips | Quantity of Chips | Price of Fish | Quantity of Fish | |
| Date 1 |
|
|
|
|
| Date 2 |
|
|
|
|
Fixed-weight GDP deflator and fixed-weight real GDP.
Date 1 Nominal GDP = $7.50 (= .50x10 + .25x10)
Date 2 Nominal GDP = 13.00 (= .75x12 + .50x8).
Date 2 real GDP in date 1 prices = 8.00 (= .50x12 + .25x8).
GDP deflator (the ratio of current price GDP to GDP in base year prices):
Date 1: 100 in the base year
Date 2: 162.5 (= 100 x 13/8)
Inflation rate: 62.5%.
Real GDP growth measured with fixed weights: 6.66% = 100 x (8-7.5)/7.5
(1 + ny) = ( 1 + y) x (1 + p)
y = [(1 + ny) / (1+p)] -1 = [(1 + 0.733)/(1 + 0.625)] -1 = 0.066
Fixed-basket CPI deflator and 'fixed-basket' real GDP.
The consumer price index uses quantities in a base year to compute the costs of the same basket of goods at 2 different dates.
CPI at date 1 = 7.50 (= .50x10 + .25x10).
CPI at date 2 = 12.50 (= .75x10 + .50x10).
Implied CPI inflation rate: 66.6% (= 100 x (12.50-7.50)/7.50).
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.
y = [(1 + ny) / (1+p)] -1 = [(1 + 0.733)/(1 + 0.666)] -1 = 0.04
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 2 Real GDP using date 2 as the base year: 13 = 0.75x12+0.5x8
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%).
So which method is better ?
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).
To see this issue in more detail consider the following
example:
| Price of Chips | Quantity of Chips | Price of Fish | Quantity of Fish | |
| Date 1 |
|
|
|
|
| Date 2 |
|
|
|
|
Date 2 Nominal GDP = 20 (= 0.5x20+2x5)
Intuitively: in this example real GDP has not changed in period 2 relative to period 1.
Fixed-weight approach:
Date 2 Real GDP (in date 1 prices) = $ 25 (= 1x20 + 1x5)
Real 'fixed weight' GDP growth: 25% = (25/20)-1
GDP deflator inflation: -20%
Nominal GDP growth = 0 = (20-20/20) = (1 - 0.2)(1 + 0.25) -1 [ny=(1+p)(1+y)-1]
CPI (fixed basket) approach:
CPI inflation: 25% = [(0.5x10 + 2x10) / 20] - 1
Period 1 Real GDP using date 2 as the base year: 25
Period 2 Real GDP using date 2 as the base year: 20
Real GDP growth using date 2 as the base year: -20%
Nominal GDP growth = 0 = (20-20/20)=(1 + 0.25)(1 - 0.20) -1 [ny=(1+p)(1+y)-1]
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 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:
Growth rate of chained GDP = {[(1 + 0.25)(1- 0.2)-1]/2} = 0
The growth rate of chained GDP is equal to zero that is the right economic answer.
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.
2. Major productivity growth in the service industries (ATM's, telecommunications, quality of health care) not measured by standard GDP measures.
Many have criticized the switch from fixed-weights to chain-weights.
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.
.
.
.
.
.
.
.
BIASES IN CPI INFLATION:
1. SUBSTITUTION BIAS
2. OUTLET BIAS
3. QUALITY CHANGES
4. NEW PRODUCTS
5. FORMULA BIAS
Entries are percentages, averages of quarterly data over the period 1970:1 to 1989:4.
Country S/Y I/Y CA/Y Y Growth Australia 24.1 24.6 1.1 3.33 Austria 26.6 25.2 0.1 2.95 Canada 23.7 22.1 1.2 2.82 France 23.3 22.2 0.2 2.83 Germany 25.1 21.4 3.1 2.51 Italy 22.8 22.7 -0.1 3.06 Japan 33.6 31.2 1.5 4.49 United Kingdom 18.2 18.2 0.0 2.38 United States 16.0 15.5 0.1 2.77
.
.
.
.
Figure 1. US Real GDP
FIGURE 2. Per Capita GDP: International Comparisons
Figure 3. Per Capita GDP: International Comparison 2
FIGURE 4
FIGURE 4'
Figure 5. GNP Growth in Germany and Japan
Figure 6
Nominal and Real GDP
Figure 7
Nominal and Real Growth Rate of GDP
Figure 8. CPI Level
and its Percentage Annual Rate of Change
Figure 9. GNP Deflator Index
and its Percentage Annual Rate of Change
