Nouriel Roubini and David Backus MBA Lectures in Macroeconomics http://people.stern.nyu.edu/nroubini/LNOTES.HTM Part I. Overview of the World Economy Chapter 1: Monitoring Macroeconomic Performance Chapter 2: Business Cycle and Financial Indicators Chapter 3: International Indicators Chapter 4: Productivity and Growth Part II. The Classical Theory of the Long-Run Chapter 5: Output and Real Interest Rates Chapter 6: Money and Inflation Chapter 7: Exchange Rates Part III. The Keynesian Theory of the Short-Run (Incomplete. Missing Part III chapters will distributed in class and available online in the near future). 8. Money, Interest Rates and Exchange Rates. Fixed and Flexible Exchange Rate Regimes.TheAsian Crisis of 1997 9. IS/LM Model in a Closed Economy 10. IS/LM Model in an Open Economy 11. Fiscal Policy 12. Monetary Policy and Commercial Banking Copyright: Nouriel Roubini and David Backus, Stern School of Business, NYU, 1998. 1 Chapter 1: Monitoring Macroeconomic Performance Growth and Business Cycles Gross Domestic Product Accounting Identities The Current Account Current Account Deficits and Foreign Debt Accumulation: A preview of the Asian crisis What Causes Current Account Deficits? Are Such Deficits Bad? Prices and "Real'' Quantities Summary Further Readings Further Web Links and Readings Growth and Business Cycles The two central issues of macroeconomics are evident in Figure 1, time series graph of real GDP (Gross Domestic Product) in the US over the last forty years. As we'll see shortly, GDP is a measure of total production of goods and services in an economy, the US being one example. The two obvious features of postwar GDP are its upward trend (GDP has generally been increasing over the postwar period) and the short-term fluctuations or "wiggles'' in this generally upward-sloping line. We refer to these two issues as economic growth and business cycles, respectively. When you look at data over periods this long, the wiggles don't look very important, and in a sense they aren't: the short-term fluctuations are a small part of the wealth of nations. But from a personal point of view these cycles can be very important, as businessmen and workers dealing with the latest 2001 recession could tell you. We'll look at both growth and cycles in this course. The classical question of economic growth is why some countries are richer and/or grow faster than others. (The two are clearly related, since countries that grow faster will eventually be richer.) Some examples are given in Figure 2, which graphs per capita GDP for three countries over the postwar period. [All are measured in 1980 US dollars.] This figure differs from the previous one, since I've expressed output in per capita (per person) terms by dividing GDP by population. This produces a more meaningful comparison between countries, since countries with more people don't automatically have higher numbers. Figure 2 illustrates a number of differences among three countries: Japan, Argentina, and the US. Perhaps the most obvious feature is that the US is the richest country: by this measure in 1985, it was 30 percent richer than Japan and almost three times as rich as Argentina. These are averages so they ignore a lot of differences at the individual level, but they give you some idea of where these nations stand economically. The comparison with Argentina gives us an idea of the enormous differences between rich and poor countries. In fact, Argentineans are relatively well off, roughly five times better off than an average person in India. But the truly remarkable country is Japan. In 1913 Argentina was about 3 times richer than Japan, now it's the opposite. Japan's remarkable performance has lasted, thus far, for over a century. Argentina, on the other hand, has gone from one of the richest countries in the world at the turn of the century to an average Latin American country economically that experienced a severe economic and financial crisis in 2001. 2 Figure 3 does the same thing for the US, China, and Korea, where again we see sharp differences between countries. China used to be one of the poorest of these countries but for the last 20 years China has been among the most rapidly growing countries in the world. Combined with China's enormous population, some estimates suggest that China is now the world's third largest market. These comparisons are so striking I find it hard to leave them, but let's turn our attention to the other aspect of macroeconomics, business cycles. From a business point of view these short-term movements in the economy are of more immediate concern. You may want to know, for example, whether the economy will be in better shape when you finish your degree or whether your airline stock is going to be worth anything in 12 months (airlines are notoriously sensitive to recessions). You get a much better picture of the short-term fluctuations in Figure 4, where we graph annual growth rates of US GDP. By annual growth rate, I mean the "year-on-year'' growth rate in quarterly data, (GDPt - GDPt-4) /GDPt-4 where GDPt is GDP in quarter t (for example the third quarter of 2005) and GDPt-4 is GDP four quarters before (for example the third quarter of 2004). Viewed from this perspective, the short-term movements seem a lot bigger than they did in Figure 1. For the postwar period as a whole the average growth rate of 3.3 percent per year is swamped by the year-to-year variations. [Statistically, we could say that the mean of 3.3 percent per year is only slightly larger than the standard deviation of 3.0 percent. A plus or minus two standard deviation interval is thus (-2.7,9.3). If you find this mysterious, review your statistics notes.] The nine downward spikes, all of which touch or pass the axis, are the nine postwar recessions, defined most simply as two consecutive quarters of declining GDP. The National Bureau of Economic Research, the de facto arbiter of business cycles in the US, has decided that the troughs (the bottom point) of these recessions occurred in November 1949, May 1954, April 1958, February 1961, November 1970, March 1975, July 1980, November 1982, April 1992 and November 2001. Note that in Figure 4 the growth rate of GDP is defined as year-on-year growth rate of quarterly GDP. Note that there is an alternative way to define the growth rate of the economy: this is the way the growth rate of GDP is usually reported by the US Government and the press. It consists of measuring 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. Accordingly, the quarterly growth rate of the economy at an annual rate (AR) is: 4 x [(GDPt - GDPt-1) /GDPt-1 ] Figure 4' shows the growth rate of GDP according to this alternative measure. As a comparison of figures 4 and 4' shows, the second way of expressing the growth rate of the economy implies a greater volatility of output growth as quarterly changes in the rates of growth are amplified when measured at annualized rates. As the annualized quarterly growth rate gives a better measure of the very recent performance of the economy, this is the measure usually reported in the press and most closely analyzed in the business and financial sector. However, the year-on-year definition gives a better measure of the growth rate of the 3 economy over a longer period, i.e. how the economy has actually grown over the last 4 quarters. A similar distinction between year-on-year growth rate and annualized quarterly growth rate holds for the other macroeconomic variables. To create quick charts of macro variables using these alternative definitions, you can use the Economic Chart Dispenser available on the Web. Tables with the most recent GDP data is available from the Bureau of Economic Analysis at the Department of Commerce. For more information on specific macroeconomic variables see the course homepage on the Hyptertext Glossary of Business Cycle Indicators. One question you might ask is why the economy experiences such large short-term fluctuations. We'll return to this later in the course. For now let me just say that recessions happen: business cycles have been a property of all economies for as long as we've had data and, despite what politicians tell us, they show no sign of going away. You can see signs of cycles in other countries in Figure 5. In Figure 5 I report growth rates of real GNP (total, not per capita) in Germany and Japan, where we see that they, too, have had substantial fluctuations, despite their higher average growth rates. For Japan, though, there would be only recessions between World War II and 1990 if we defined a recession, as is typically done in the US, as negative growth. Note, however, that in the 1990s, Japan experience a period of protracted economic stagnation. The average growth rate per year was close to zero between 1992 and 1995. Growth recovered in 1996 but such recovery fizzled in 1997 when the economy went again into a slump. The weak economic performance of Japan in the 1990s and 1997 in particular contributed to exacerbate the 1997 economic crisis in East Asia: as Japan is a leading export market for many East Asian countries, the stagnation of growth in Japan in this decade led to a reduction (since 1995) in the export growth rate of many East Asian countries.