Lecture 1

National Income Accounting 33840

September 26, 2014

“Consistent with its statutory mandate, the Federal Open Market Committee seeks monetary and financial conditions that foster maximum employment and price stability.”

Minutes of the July 29-30 2014 Meeting of the Federal Open Market Committee

“In particular, to further its long-run objectives, the Committee seeks conditions in reserve markets consistent with federal funds trading in a range from 0 to 1/4 percent.”

Minutes of the July 29-30 2014 Meeting of the Federal Open Market Committee

“Beginning in August, the Desk is directed

to purchase longer-term Treasury securities at a pace of about $15 billion per month and to purchase mortgage-backed securities at a pace of about $10 billion per month.”

Minutes of the July 29-30, 2014 Meeting of the Federal Open Market Committee

“The Committee directs the Desk to

maintain its policy of rolling over maturing Treasury securities into new issues and its policy of reinvesting principal payments on all agency debt and agency mortgage-backed securities in agency mortgage-backed securities.”

Minutes of the July 29-30, 2014 Meeting of the Federal Open Market Committee

“The Federal Open Market Committee seeks monetary and financial conditions that will foster price stability and promote sustainable growth in output.”

Minutes of the December 11-12 2012 Meeting of the Federal Open Market Committee

The FOMC Minutes (circa 2012)

“The FOMC is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates.”

FOMC statement of longer-run goals and policy strategy, January 25 2012

Why the Change in Language? (Maybe the Federal Reserve Act has something to do with it?)

Basic Growth Accounting: Connecting a Few Dots

GDP growth = Productivity growth + Capital stock growth

+ Employment growth (If productivity growth is “exogenous” and if the capital stock changes slowly, pursuing maximum employment is roughly equivalent to pursuing maximum sustainable growth.)

Our Mission

To make sense of this statement. 1. Build a model that helps understand

how output, employment, prices, interest rates (and other stuff) are determined.

Our Mission To make sense of this statement. 2a. Figure out what it means to set the

funds rate in the range of 0 to ¼ percent (or anything else for that matter).

2b. Figure out all that other stuff the Fed has been up to.

Our Mission

3. Help the FOMC

get it right next time.

Gross Domestic Product

Gross Domestic Product is a measure of the value of all final goods and services newly produced within a specified country’s borders during a specified period of time (usually one year or one quarter).

HOW IS GDP MEASURED?

Three ways to capture total (aggregate) economic activity

We can measure GPD in market “values” from three “theoretically” identical measures:

1. How much is produced.

2. How much is earned.

3. How much is purchased.

The circular flow concept

Everything produced is an income source to someone.

Everything produced is paid for (is an expenditure) by someone.

Everything produced, is purchased by someone…

Total Production = Total Expenditure

Gross Domestic Product: The Expenditures Approach

Y = C + I + G + (X - M)

To calculate GDP:

Exports

Investment

Consumption Government Purchases

Imports

Problems with GDP as a measure of welfare

Let’s stipulate that we want to talk Real, Per Capita GDP. GDP still falls short because income per se does not generate “happiness”, or “well-being.”

•  Leisure isn’t valued •  Non-market work isn’t counted

Problems with GDP as a measure of welfare

Source: “Hours Worked: Long-Run Trends,” Jeremy Greenwood and Guillaume Vandenbrouke, September 2005

Market hours worked by women have increased dramatically since 1900, but housework hours have decreased

Source: “A Summary of Trends in U.S. Time Use: 1965-2005,” Mark Aguiar and Erik Hurst, May 2008

Leisure Enjoyed by Women Has Increased Since 1965, Despite An Increase In Market Hours

Leisure Enjoyed by Men Has Increased Since 1965, But Less Rapidly Than Market Hours Have Declined

Source: “A Summary of Trends in U.S. Time Use: 1965-2005,” Mark Aguiar and Erik Hurst, May 2008

•  Leisure isn’t valued •  Non-market work isn’t counted •  Consumption is not equal to income •  Income inequality doesn’t matter

Problems with GDP as a measure of welfare

Life Expectancy

Public and Private

Consumption Relative to

Income

Leisure (and Home

Production)

Inequality in Consumption

Western Europe

+ - + +

Eastern Europe - - + - Latin America - + - - North Africa/Middle-East

- - + -

Coastal Asia - + - - Sub-Saharan Africa

- + - -

Cross-regional contributors to economic welfare relative to the United States (2001)

Source: “Beyond GDP? Welfare Across Countries and Time,” Charles I. Jones and Peter J. Klenow, February 2011

Source: “Beyond GDP? Welfare Across Countries and Time,” Charles I. Jones and Peter J. Klenow, February 2011

Income and the Jones-Klenow Measure of Welfare Are Correlated 0.95 in 2000

Source: “Beyond GDP? Welfare Across Countries and Time,” Charles I. Jones and Peter J. Klenow, February 2011

Income and Jones-Klenow Welfare Growth Are Correlated 0.82 for the 1980-2000 Period

•  Leisure isn’t valued •  Non-market activities aren’t counted •  Consumption is not equal to income •  Income inequality doesn’t matter •  Non-economic “values” are omitted

Problems with GDP as a measure of welfare

The HDI is based on: 1. Long and healthy life --- Life expectancy

2. Access to knowledge --- Mean adult educational attainment --- Expected years of education for children of school entrance age

3. Standard of living --- Gross national income

Another alternative: The United Nations Human Development Index (HDI)

Source: Human Development Index 2011, http://hdrstats.undp.org/images/explanations/USA.pdf

For the United States, the HDI has been growing faster than national income over the past decade

Source: Human Development Index 2011, http://hdrstats.undp.org/images/explanations/USA.pdf

•  Leisure isn’t valued •  Non-market activities aren’t counted •  Consumption is not equal to income •  Income inequality doesn’t matter •  Non-economic “values” are omitted •  Externalities may be missed

Problems with GDP as a measure of welfare

The Genuine Progress Indicator: United States

Source: “The Genuine Progress Indicator 2006”, Dr. John Talberth, Clifford Cobb, and Noah Slattery, February 2007

The Genuine Progress Indicator Consumption + (consumer durable services

+ services of highways and streets + net investment (not foreign-financed)) X discount for

income inequality

+ value of time in leisure, parenting, volunteering, education

- value of leisure lost in working and commuting - social costs of pollution (including noise), loss of

wetlands, farm land, forests, depletion of nonrenewable resources

- household costs of pollution abatement, crime and crime prevention

- cost of unemployment (value of “unwanted” leisure)

The Largest Negative to the GPI is Natural Resource Depletion and the Cumulative Effect of “Global Warming”

Source: “The Genuine Progress Indicator 2006”, Dr. John Talberth, Clifford Cobb, and Noah Slattery, February 2007

The Genuine Progress Indicator: Growth Rates

Source: “The Genuine Progress Indicator 2006”, Dr. John Talberth, Clifford Cobb, and Noah Slattery, February 2007

•  GDP growth is arguably highly correlated with underlying economic welfare

•  We will generally think of growth in the

level of GDP as a reasonable indicator of economic progress, bearing in mind all appropriate caveats

Bottom Line

36

-0.1

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

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 09 11 13

Source: Bureau of Economic Analysis

GDP  Components  Share  of  total  nominal  GDP  

through Q2 2014

Government  

Investment  

Net  Exports  

Consump4on  

The Components of Consumption

1960 2013

Source: Bureau of Economic Analysis

Nondurables

Durables

Services

Nondurables

Durables

Services

The Components of Investment

1960 2013

Source: Bureau of Economic Analysis

Nonresidential Structures

Residential Structures

Equipment & Software

Nonresidential Structures

Residential Structures Equipment &

Software

Nonresidential Structures

Residential Structures Equipment &

Software

Investment: Pre- and Post- Housing Crash

2004 2013

Source: Bureau of Economic Analysis

Nonresidential Structures

Residential Structures Equipment &

Software

The Components of Government Purchases

1960 2013

Source: Bureau of Economic Analysis

State & Local Federal Defense

State & Local

Federal Defense

Federal Non-defense Federal

Non-defense

Everything produced, is income to someone…

Total Production = Total Income

42

3000

5000

7000

9000

11000

13000

15000

17000

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 09 11 13

Source: Bureau of Economic Analysis

GDP  and  GDI  SAAR,  Chained  2009  Bill.  $    

through Q2 2014

Gross  Domes4c  Product  

Gross  Domes4c  Income  

The Components of Personal Income

Source: Bureau of Economic Analysis

11960  

72%

Compensation

Proprietors Income Rental

Dividends

Interest

Net Transfers

2014  

63%

Macroeconomics in 6 Easy Bullet Points

Macro in Bullet Points

1.  Ultimately, fundamentals (not

demand) determine GDP.

(If “tighter” monetary policy slows down the economy, something isn’t working right.)

Macro in Bullet Points

2. In the end, interest rates are

determined in the market for goods and services.

(Interest rates are low, but mostly it isn’t because of the Fed – or at least not for the reason you might think.)

Macro in Bullet Points

3. Prices are what they are (neither

necessarily good nor necessarily bad).

(Right now, rising interest rates would look like a good thing.)

Macro in Bullet Points

4. The future is now (expectations

rule).

(The impact of any particular fiscal or monetary policy depends not on the government does today, but on what people expect it to do down the road.)

Macro in Bullet Points

5.  Inflation is everywhere and always a

monetary phenomenon.

(But it’s complicated: Maybe all that money the Fed printed doesn’t matter.)

Macro in Bullet Points

6. A higher funds rate does not

necessarily mean monetary policy is getting “tighter.”

(Maybe it does, maybe it doesn’t!)

End of Lecture 1