FIN 30220: Macroeconomic Analysis

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FIN 30220 Macroeconomic Analysis

• Using Economic Data

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There are three kinds of lies Lies, Damn Lies,
and Statistics - Mark Twain
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Principle 1 What exactly are you trying to
measure? Is your definition consistent with what
you are trying to measure?
Example Poverty in the US
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Lets see how we compare to other parts of the
world
Austria 6
Russia 16
England 14
Canada 11
US 12
Brazil 31
China 8
Mexico 14
Iran 18
Chad 80
Bolivia 60
Zimbabwe 68
Argentina 24
Australia 10
But, How would you define poverty?
Source CIA Factbook
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Poverty was defined by Mollie Orshansky of the
SSA in 1964 as 3 times the cost of the Dept. of
Agricultures Low cost food plan
That number has been indexed by inflation every
year (The Johnson Administration later
substituted the economy food plan)
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USDA Food Plans 1964
(Poverty Line in 1964)
(Poverty Line Today)
Average Annual Inflation Rate
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Food Budget as a percentage of household income
1964
Lower Income Households spent around 33 on Food
in 1964
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The Average Family Budget 2003
The Average Family Spends Nowhere near 33 on
Food Today!!
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Food Budget as a percentage of household income
2003
In Fact, No Family Spends Anything Near 33 on
Food Today!!!
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Suppose we use current food prices and the
current budget share
(Poverty Line in 2006?)
Assuming Food is 16.5 of ones budget
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Actual Calculation
So, which is it and why should we care?
Redefined Household Budget (Current food prices)
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A more important question Is it absolute
income that we really care about?
The Simpsons have a household income of 35,000.
Median income is Springfield is 50,000
The Griffins have a household income of 45,000.
Median income is Quahog is 85,000
Which of these two families do you think is
happier?
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Relative poverty measures define poverty as a
certain percentage of median household income
Poverty Line for 3.5 Person Household 20,000
(40 of Median)
Median Household Income 50,000
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Altering the definition of poverty can make a big
difference when comparing across countries!!
It also makes a big difference when looking
across time periods!
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Defining Poverty

• International Poverty
• Of the 184 member countries of the world bank. 52
  countries are considered high income per
  capita income of more than 9,206/yr
• 66 countries are considered low income (less
  than 746/yr)
• Currently the international poverty standard is
  1.08/day!!

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Principle 2 How is your variable
measured? Example U.S. Unemployment
1991 Recession
2001 Recession
2007 Recession
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Each month, the Department of Labor surveys
60,000 households. Each household is asked a
series of questions
1) Are you currently working? (Note no mention
of part time or full time)
YES
You are employed (144.2 Million)
No
1) Have you looked for a job in the past 30
days?
YES
You are unemployed (10.3 Million)
No
Unemployment Rate (UR)
Unemployed

Labor Force
You are not in the labor force (80 Million)
10.3

.066 (6.6)
144.2 10.3
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Over the same month, the Department of Labor
surveys 400,000 businesses and asks one question.
1) How many employees are currently on your
payroll?
Total Non-Farm Payrolls (136.1 Million)
Wait a minute, thats not what the household
survey reported??? Which is it ???
1) Are you currently working? (Note no mention
of part time or full time)
YES
You are employed (144.2 Million)
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The two surveys reported very similar numbers
until recent years
2001 Recession
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However, the establishment survey is subject to
fairly large revisions
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The Establishment Survey Will often times Double
Count Jobs
Suppose you quit your job at company A and find a
new job at company B if this is dome in the
same payroll period (most payrolls are bi-weekly)
you will be counted twice!!
No Turnover
Turnover
Pay Period
Pay Period
Job at Company A
Job at Company B
count 1 payroll job
count 2 payroll jobs
In months with high job turnover, the
establishment survey will overstate employment.
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Average US Labor Market Turnover
8.11M jobs are gained per quarter
FYI Worst-case estimates predict outsourcing
costs us 55,000 jobs per quarter.

• 7.71M jobs arelost per quarter

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Household Survey vs. Establishment Survey
The household survey includes agricultural
workers, self employed workers and private
household workers. The establishment survey does
not.
The household survey counts people on unpaid
leave as employed the establishment survey does
not.
The household survey only counts people over the
age of 16 the establishment survey is not
limited by age.
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Other Biases in the Unemployment Rate

• The unemployment rate doesnt count
  underemployment (those that would like to work
  full time, but only work part time)
• The discouraged worker effect Those that have
  given up trying to find a job are counted as not
  in the labor force rather than unemployed
• Selection bias those that are unemployed are
  more likely to answer the survey.
• Moral hazard due to unemployment insurance, it
  is difficult to tell how hard individuals are
  trying to find work

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Principle 3 Is your variable in terms of
current prices or fixed prices (Real vs. Nominal)
Example The Top 10 All Time Grossing Films (in
Millions US)

• Titanic (1997) 600
• The Dark Knight (2008) 492
• Star Wars Episode IV (1977) 460
• Shrek 2 (2004) 436
• ET the Extraterrestrial (1982) 433
• Star Wars Episode I (1999) 431
• Pirates of the Caribbean Dean Mans Chest
  (2006) 423
• Spiderman (2002) 403
• Star Wars Episode III (2005) 380
• Lord of the Rings Return of the King (2003) 377

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Real vs. Nominal Variables
Nominal Variables are in terms of a current
dollars. For example, youre starting salary
after college might be 50,000 per year.
Real variables are in terms of some tangible
commodity. Real variables measure purchasing
power. If a gallon of gas costs 2.00, then we
can calculate your real income.
Nominal Income
50,000
Real Income
25,000

Price
2.00
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In 1997, a gallon of gas cost 1.26
Nominal Gross
600M
Real Gross

476M
Price
1.26
(Gallons of Gas)
In 1977, a gallon of gas cost .62
Nominal Gross
460M
Real Income
742M

Price
.62
(Gallons of Gas)
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Usually, the commodity used for real variables
is a particular years dollars. Suppose we want
both grosses to reflect 1997 gas prices.
Target year Price
Real X
Nominal X
Current Year Price
Target Year
1.26
1.26
Real Gross
Real Gross
460M

600M

.62
1.26
Current Year
935M
600M
( 1997 Dollars)
( 1997 Dollars)
These two dollar figures are comparable because
they represent the same years dollars!
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The Consumer Price Index (CPI) is an attempt to
capture the average price of all goods in the
economy. (Lets scale these grosses to reflect the
general price level in 2006)
CPI(1997) 159.1 CPI(2006)
198.3
CPI (2006)
Nominal Gross
Gross (2006)
CPI (1997)
198.3
747M
600M

159.1
CPI(1977) 58.5
CPI(2006) 198.3
CPI (2006)
Nominal Gross
Gross (2006)
CPI (1977)
198.3
1,559M
460M

58.5
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The Top 10 All Time Grossing Films (in Millions)
Inflation Adjusted (2008 Dollars)

• Gone With the Wind (1939) 1,390
• Star Wars Episode IV(1977) 1,225
• The Sound of Music(1965) 979
• ET The Extraterrestrial(1982) 978
• The Ten Commandments (1956) 901
• Titanic (1997) 883
• Jaws (1975) 881
• Dr. Zhivago (1965) 854
• The Exorcist (1973) 760
• Snow White (1937) 750

Note The Dark Knight falls to 34
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Principle 3 Annualizing
Example Treasury Yields
Suppose that you buy a 1,000, 90 Day Treasury
Bill for 994
Alternatively, you could buy a 1,000, 5 year
bond for 902
90 Days from now, you receive 1,000 from the
government
5 years from now, you receive 1,000 from the
government
1,000 - 994
1,000 - 902
X 100 .6
X 100 10.86
994
902
Which of these two assets is paying a higher
return?
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Suppose that you could earn .6 interest every
quarter (90 days). How much would you have in a
year?
1
1.006
1.012
1.018
1.024
2
3
4
1(1.006)
1(1.006)
1(1.006)
1(1.006)
You earned 2.4 (Annualized)
For the 5 year bond, we do the same process in
reverse (how much would you have to earn per year
to get a 10.86 return after 5 years)?
1
??
??
??
??
1.1086
2
3
4
5
1(1i)
1(1i)
1(1i)
1(1i)
1(1i)
You earned 2.0 (Annualized)
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Principle 5 What frequency are you interested
in?
Example Tax Cuts, Tax Revenues and VooDoo
Economics
The Bush Tax Cuts of 2001 2003 lowered marginal
tax rates across the board, lowered the capital
gains tax, eliminated the estate tax, and
lowered the marriage penalty
The tax cut was advertised as the largest tax
cut in history
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What do we mean by the cost of a tax cut,
anyways?
Suppose that the Griffin family has a household
income of 50,000. Currently, the income tax
rate is 20 of all income earned
Under the current tax code, the Griffins pay
10,000 per year in Taxes.
The cost of the tax cut is the 5,000 in lost
revenues
If the government cuts the tax rate to 10, then
the Griffins tax bill falls to 5,000
By this measure, the Bush Tax cuts have a price
tag of around 130 Billion per year!!
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Lets take a look at previous marginal tax rate
changes to put the Bush tax cut in a historical
context.
Wilson 1917
Coolidge 1925
FDR 1933
Kennedy 1964
Reagan 1981
Bush 2001/2003
Source Congressional Budget Office
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Given an income distribution in 1964, 1981, and
2001/2003, we can estimate the per year cost of
the three major tax cuts
Whats the problem with comparing these numbers?
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When expressed in real terms as a percentage of
GDP, the Bush tax cuts arent so big after all!
Kennedy 1964
Cost (in 1964 dollars) 11.5B CPI 30.9 Real
GDP 2998.6B
175.1
11.5B
67.6B
(2.25 of GDP)
30.9
Reagan 1981
Cost (in 1981 dollars) 38.3B CPI 87.0 Real
GDP 5,291.7B
175.1
38.3B
79.9B
(1.5 of GDP)
87.0
Bush 2001/2003
Cost (in 2003 dollars) 134.6B CPI 175.1 Real
GDP 10,301B
175.1
134.6B
134.65B
(1.3 of GDP)
175.1
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Lets return to the Griffin family. The Griffin
family has a household income of 50,000.
Currently, the income tax rate is 20.
Under the current tax code, the Johnsons pay
10,000 per year in Taxes.
The drop in the tax rate caused revenues to
increase rather than decrease!
Suppose that a drop in the marginal rate
encourages Lois Griffin to go back to work. With
the two income earners, the Griffin family income
rises to 120,000. At the 10 rate, their tax
rises to 12,000
Could this happen?
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Tax Revenues (Tax Rate) (Tax Base)
The basic logic behind the Laffer Curve is that
the tax base should be negatively related to the
tax rate.
Tax Revenues
Is there evidence of a Laffer curve in practice?
Tax Rate
0
100
Revenue Maximizing Rate
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Tax Revenues
History suggests that taxes are two high, but be
careful
Tax Rate
0
100
Revenue Maximizing Rate
Source Congressional Budget Office
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Once we account for price changes, the Laffer
curve effect starts to disappear
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After correcting for price changes, it appears
that empirical evidence suggests the presence of
a Laffer curve. However, we need to be careful.
Tax cuts generally take place during recessions.
Tax revenues are below normal during recessions

• Economic data can be can be broken into four
  components
• Trend (many years)
• Business Cycle (1-2 years)
• Seasonal (Months)
• Noise (very short term)

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Suppose that we were to plot GDP over time. It
would look something like this. What do you see?
Expansions are periods of above trend growth
Recessions are periods of below trend growth
GDP
Trend growth of real GDP is around 3 per year
Time
This trend/cycle in GDP appears in all macro data
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The Laffer effect of a tax cut should affect the
trend, but not the cycle
New Tax Code
GDP
Old Tax Code
This is what we have measured
This is what we should be measuring
Time
In other words, we have overstated the Laffer
effect in the previous slides