Chapter 1 THE ESSENTIAL MACROECONOMIC AGGREGATES 1. Gross Domestic Product (GDP) 2. “Real” GDP and GDP deflator 3. Investment and consumption 4. A first macroeconomic reconciliation 5. The second macroeconomic reconciliation 1 THE ESSENTIAL MACROECONOMIC AGGREGATES CHAPTER 1 The Essential Macroeconomic Aggregates In this first chapter, our aim is to give an initial definition of the essential macroeconomic variables, listed in the table below, and taken from the I. Each chapter of this OECD Economic Outlook for December 2004.1 We have chosen to book uses an example from illustrate this chapter using the example of Germany, but we might as well a different country. have chosen any other OECD country, since the structure of the country chapters in the OECD Economic Outlook is the same for all countries. X I. Table 1. Main macroeconomic variables Germany,a 1995 euros, annual changes in percentage 2002 2003 2004 2005 2006 Private consumption –0.7 0.0 –0.7 0.8 1.9 Gross capital formation –6.3 –2.2 –2.0 0.6 3.4 GDP 0.1 –0.1 1.2 1.4 2.3 Imports –1.6 3.9 6.4 4.9 7.5 Exports 4.1 1.8 8.1 5.7 8.1 Household saving ratio1 10.5 10.7 11.1 11.1 10.8 GDP deflator 1.5 1.1 0.9 0.8 0.9 General government financial balance2 –3.7 –3.8 3.9 –3.5 –2.7 1. Net saving as % of net disposable income. 2. % of GDP. a) The report dates from December 2004. At that time, the data for 2004, 2005 and 2006 were forecasts by the OECD economists. The data for 2002 and 2003 were actual observations by the Statistiches Bundesamt, the FRG’s statistical office. Source: OECD (2004), OECD Economic Outlook, December No. 76, Volume 2004, Issue 2, OECD, Paris. StatLink: http://dx.doi.org/10.1787/563276026371 Comments on Germany made by OECD economists in December 2004 included the following: “Based on strong export growth, the German economy is recovering from three years of stagnation. Weak domestic demand is still weighing on activity although there are signs that investment is strengthening. Private consumption declined as consumers’ confidence remained subdued and rising unemployment, tighter social security benefits, and accelerating consumer prices reduced disposable income growth. The general government deficit is likely to remain between 3½ and 4 per cent of GDP this year and next, not falling below 3 per cent before 2006.” 14 UNDERSTANDING NATIONAL ACCOUNTS – ISBN 92-64-02566-9 – © OECD 2006 THE ESSENTIAL MACROECONOMIC AGGREGATES 1. Defining GDP 1 According to the OECD economists, who were making their II. Definitions of terms comments at the end of 2004, Germany was, at last, expected to appearing in bold are experience an acceleration of growth in its gross domestic product X II. available in the glossary of (commonly known as GDP) in 2006. The table shows the stagnation of this book. GDP in 2002 (+0.1%) and in 2003 (–0.1%), followed by an expected slight recovery in 2004 (+1.2%) and then by a slightly stronger one in 2005 III. In practice, most OECD (+1.4%). The two tenths of a percentage point difference between 1.2% countries technically and 1.4% may seem very small, but it must never be forgotten that national compile their national accounts in millions, and accounts variables are very often measured in billions. X III. In the case of Germany, 1% of GDP amounts to roughly 22 billion euros, so that 0.1% is thus many tables published equivalent to 2.2 billion euros, corresponding to the total annual net appear in millions. But this is earnings in 2003 of roughly 67 000 workers, a substantial number. far from meaning that the data are accurate at the level In this chapter, we begin by defining GDP, before turning to the other of millions. It is wise to round principal indicators used by the OECD economists: private consumption, these data to billions. gross fixed capital formation, GDP deflator, household saving ratio, and financial balance of general government. For all the national accounts data discussed in this chapter, we refer the reader to the OECD website for this book, or to the general OECD website under the heading “quarterly national accounts” or “annual national accounts”. The quarterly national accounts are more pertinent for those who wish to have the most recent figures. 1. Defining GDP GDP, gross domestic product, is the most frequently used indicator in the national accounts. It lies at the heart of the entire system of national accounts, and its definition is now internationally agreed upon (see Box 1 on “The reference manuals”). GDP combines in a single figure, and with no double counting, all the output (or production) carried out by all the firms, non-profit institutions, government bodies and households in a given country during a given period, regardless of the type of goods and services produced, provided that the production takes place within the country’s economic territory. In most cases, it is calculated quarterly or annually, but it can also be calculated monthly. However, measuring a country’s total output is not a simple matter (see Section “Accuracy” and “Limitations and pitfalls” at the end of this chapter), and national accountants have therefore had to devise innovative methods of calculation. The output of a single firm can be measured fairly easily. In the case of a firm making pasta, for example, it can be measured as tonnes of pasta made during the year, or, if we multiply the number of tonnes by the price of the pasta, by the amount of output valued in dollars (or in euros in the case of Germany, since this is the national currency). But we shall see that it makes little sense to add together the output measured in dollars from all firms to UNDERSTANDING NATIONAL ACCOUNTS – ISBN 92-64-02566-9 – © OECD 2006 15 THE ESSENTIAL MACROECONOMIC AGGREGATES 1 1. Defining GDP Box 1. The reference manuals The standards governing national accounts are enshrined in two international reference manuals: the “System of National Accounts 1993” (SNA 93), which is recognised globally, and the European version of this called the “European System of Accounts 1995” (ESA 95). The global manual (SNA 93) is co-signed by the five major international economic organisations: the United Nations, the International Monetary Fund, the OECD, the World Bank and the European Commission. The European manual is totally compatible with the global manual and includes additional useful details. It also has a more legally binding character because, according to European regulations, EU member countries are obligated to implement it. These manuals have contributed substantially to improving the international comparability of data, although further progress still has to be made in this endeavor (see Chapter 3). The current complete version of SNA 93 is available online: http://unstats.un.org/unsd/sna1993/toctop.asp. A new version is now being prepared and due to be published in 2008. arrive at a macroeconomic figure. That is because the result of this calculation depends heavily on the way the firms are organised. Take again the example of the pasta manufacturer and compare two different production scenarios in a given region. Suppose that in the first year there is only one firm, firm A, that makes both the pasta and the flour used to make the pasta. Its output amounts to 100 000 dollars, corresponding to 100 tonnes of pasta, with each tonne valued at 1 000 dollars. Now suppose that the following year, firm A is split into two, with firm A1 specialising in making flour and selling 30 000 dollars’ worth to firm A2, which carries out the final production of pasta. Firm A2 makes the same quantity of pasta as in the first year, i.e. 100 tonnes, and at the same price, i.e. 1 000 dollars per ton. Pasta industry Year 1 Firm A Output $ 100 000 Year 2 Firm A1 Firm A2 Output $ 30 000 $ 100 000 In the first year, the output in this region will be worth 100 000 dollars; in the second year, the value of total output could be the sum produced by firm A1, i.e. 30 000 dollars, and that of firm A2, i.e. 100 000 dollars, resulting in a total of 130 000 dollars. But it would clearly be absurd to use this total as our macroeconomic indicator of activity in the region. It shows an increase of 30% (130 000/100 000 = 1.30, often written as + 30%, or more simply 30%), when in fact no change at all took place at the strictly macroeconomic level. 16 UNDERSTANDING NATIONAL ACCOUNTS – ISBN 92-64-02566-9 – © OECD 2006 THE ESSENTIAL MACROECONOMIC AGGREGATES 1. Defining GDP 1 The same quantity of pasta was produced at the same price. All that changed was the legal and commercial organisation of the firms. The above discrepancy generated the national accountants’ innovative idea of calculating the contribution of each firm not as its output, but as its value added. This expression is profound since it consists of measuring the value that the firm adds to that of the firms that supply its inputs. Let us consider the pasta example again. Compared with the situation in the first year, when there was only firm A, the value added by firm A2 is not equal to 100 000 dollars. That is because firm A2 buys 30 000 dollars’ worth of flour, whereas previously it had made this flour itself and did not count this as output.