Financial Institutions Financial Institutions and Marketsand Markets

FIN 304FIN 304

Dr. Andrew L. H. ParkesDr. Andrew L. H. Parkes

Day 4Day 4““How do financial markets work?”How do financial markets work?”

卜安吉卜安吉

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Price IndicesPrice Indices

GDP deflatorGDP deflator

Uses Current Year Uses Current Year Quantities – Bought todayQuantities – Bought today

Consumer Price IndexConsumer Price Index

Uses Base Year Quantities Uses Base Year Quantities – Bought in the Base Year – Bought in the Base Year

Are they the same?Are they the same?

Shanghai Dow Stock Index – WSJ

Over the last year!

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Price IndicesPrice Indices

GDP deflatorGDP deflator

Uses Current Year Uses Current Year Quantities – Bought todayQuantities – Bought today

Consumer Price IndexConsumer Price Index

Uses Base Year Quantities Uses Base Year Quantities – Bought in the Base Year – Bought in the Base Year

Are they the same?Are they the same?

Shanghai Composite Index – Yahoo!.com almost a year ago!

http://finance.yahoo.com/q/bc?s=000001.SS&t=2y&l=on&z=m&q=l&c=

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What did you buy in 1967?What did you buy in 1967?

OK then try 1982?OK then try 1982?

These are the base These are the base yearsyears

Were the goods the same?Were the goods the same?

Notice even our example!Notice even our example!

Chain Weighted GDP Chain Weighted GDP Price index nowPrice index now

Dow Jones World Stock Index

One year ago!

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What did today’s purchase cost What did today’s purchase cost in 1982? 1967? in 1982? 1967?

That’s the Paasche That’s the Paasche IndexIndex

Today’s goods, base Today’s goods, base year pricesyear prices

An MP3 player in 1982?An MP3 player in 1982?

A digital Camera?A digital Camera?

So there are problems So there are problems with Price indices …with Price indices …

U. S. Treasury Bill One year ago:

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Cost of Living AdjustmentCost of Living Adjustment

Pay attention to the Pay attention to the definition of the CPI definition of the CPI in class!in class!

CPI in U.S. is what?CPI in U.S. is what? Cost of Living is Cost of Living is

measured by the CPImeasured by the CPI Social Security and Social Security and

other wages are other wages are adjusted using CPIadjusted using CPI

U.S. Department of LaborBureau of Labor Statistics

http://www.bls.gov/cpi/

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List of the ProblemsList of the Problems

1.1. Substitution BiasSubstitution Bias

2.2. Introduction of new Introduction of new goodsgoods

3.3. Unmeasured quality Unmeasured quality changeschanges

4.4. Typical Average FamilyTypical Average Family

Four problems with using the CPI for a Perfect measure of a COLA

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Industrial Production & C.U.Industrial Production & C.U.

See the “downtick” in Industrial Production (often used for Real GDP because the numbers are reported monthly).

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Industrial Production & C.U.Industrial Production & C.U.

More evidence that the economy is beginning to “turn around,” as you can see from the pictures – the turn from down to up!http://www.nytimes.com/2009/09/17/business/economy/17econ.html?hpw

September 17, 2009September 17, 2009 Financial Institutions & Markets, DaFinancial Institutions & Markets, Day 4y 4

1010http://www.nytimes.com/2008/12/08/business/economy/08econ.html?th&emc=th

September 17, 2009September 17, 2009 Financial Institutions & Markets, DaFinancial Institutions & Markets, Day 4y 4

1111http://www.nytimes.com/2008/12/06/business/economy/06jobs.html?hp

September 17, 2009September 17, 2009 Financial Institutions & Markets, DaFinancial Institutions & Markets, Day 4y 4

1212http://www.nytimes.com/2008/12/06/business/economy/06idle.html?hp

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What have I Hammered ON in What have I Hammered ON in Class? Class?

3 Goals of any 3 Goals of any MacroeconomyMacroeconomy

Full EmploymentFull Employment Economic Growth Economic Growth Price StabilityPrice Stability

Sources: NYT and BLS – Sept. 16, 2009

http://www.nytimes.com/2009/09/17/business/economy/17econ.html?hpw

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Notice “They” always help me! Notice “They” always help me!

Whatever I TeachWhatever I Teach

The Markets helpThe Markets help The Fed helpsThe Fed helps Actually, it really Actually, it really

happens every single happens every single day!day! Sources: NY Times

above with Labor report

Mostly energy prices that have changed, although the prices of health care have also changed.

See the Table for annual changed in EACH category as well.

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Problem Set #2 Problem Set #2

TUTORIAL - CheersTUTORIAL - Cheers

Let’s work on Problem Set Let’s work on Problem Set #2 in class for a while at #2 in class for a while at least.least.

U.S. Males around New U.S. Males around New Years call this College Years call this College BOWL TIMEBOWL TIME

See ESPNSee ESPN BOWLING TIME!!! (College - American Football)