US Economy PowerPoint Presentation

Slide 1 -

Measuring the US Economy Economic Indicators

Slide 2 -

Annualized Rates Example: GDP Q3 (Final) = $11,814.9B (5.5%) Q2: GDP = $2,914.38 B X 4 = $11,657.5 B Q3: GDP = $2,953.73 B X 4 = $11,814.9 B ($11,814.9 - $11,657.5) X 100 = 1.35% X4 = 5.5% $11,657.5 Understanding the Lingo

Slide 3 -

Annualized Rates Supposed that prices increased by .3% during the month of November. The annualized inflation rate is .3%X12 = 3.6% Understanding the Lingo

Slide 4 -

Nominal (Current) Dollars vs. Real (Constant) Dollars Example: GDP(Q2) = $11,657.5 GDP(Q3) = $11,814.9T (5.5%) CPI(Q2) = 111.2 CPI(Q3) = 112.4 (4.3%) Real GDP(Q2) = (11,657.5/111.2)*100 = $10,483.36 Real GDP(Q3) = (11,814.9/112.4)*100 = $10,511.47 ($10,511.47 - $10,483.36) X100 X 4 = 1.07% $10,483.36 Understanding the Lingo

Slide 5 -

Understanding the Lingo Seasonally Adjusted

Slide 6 -

Understanding the Lingo The X12 method estimates changes that occur in the same month each year and are generally of the same magnitude/direction. This seasonal component is then subtracted out.

Slide 7 -

Understanding the Lingo Moving Averages Example: Consider the following monthly Inflation Statistics (Monthly % Changes)

Slide 8 -

Understanding the Lingo Moving Averages A moving average takes out the volatility by averaging several observations. For example, a MA(3) would average the current observation with the previous 2 observations.

Slide 9 -

Revisions ALL ECONOMIC DATA IS CONSTANTLY BEING REVISED!!! Example: GDP is reported three times Q3(Advance): 3.7% Q3 (Preliminary): 3.9% Q3 (Final): 4.0% Understanding the Lingo

Slide 10 -

Understanding the Lingo Consensus Forecasts Most of the news services construct consensus surveys by polling economists for their predictions on key indicators

Slide 11 -

Benchmarking Some indicators are reported relative to some benchmark. Example: Consumer Confidence in December was 102.3 (1985 = 100) Example: The CPI in November was 191.0 (1982-1984 = 100) Understanding the Lingo

Slide 12 -

Understanding the Lingo The Business Cycle Since WWII, the US has experienced 10 Business cycles with the average recession lasting 10 months. The most recent cycle was 2001: Peak (March 2001) Trough (November 2001)

Slide 13 -

The government releases over 50 statistics per month/quarter!! They can be roughly divided into 5 categories Consumer Sector Business Sector Public Sector International Prices So Many Statistics….So Little Time!

Slide 14 -

Consumer Sector (70% of Economic Activity) Retail Sales (Census Bureau) Consumer Credit (Federal Reserve) Personal Income and Spending (BEA) Employment Report (BLS) New Claims For Unemployment Insurance (Dept of Labor) Consumer Confidence/Sentiment (Conference Board/U. of Michigan) Auto Sales (Dept. of Commerce) Major Indicators

Slide 15 -

Business Sector(17% of Economic Activity) Industrial Production (Federal Reserve) Capacity Utilization (Federal Reserve) ISM Index (Institute for Supply Management) Durable Goods Orders (Census Bureau) Factory Orders (Census Bureau) Housing Starts (Census Bureau) New/Existing Home Sales (Nat. Assoc. of Realtors/Census Bureau) MBA Mortgage Applications (Mortgage Bankers Assoc.) Business inventories (Census Bureau) Major Indicators

Slide 16 -

Public Sector(19% of Economic Activity) Construction Spending (Census) Federal Budget Report (Treasury Dept) International Sector (-6% of Economic Activity) Net Exports (Bureau of Economic Analysis) Current Account (Bureau of Economic Analysis) Major Indicators

Slide 17 -

Prices Consumer Price Index (BLS) Producer Price Index (BLS) Employment Cost Index (BLS) Non-Farm Productivity (BLS) Import/Export Prices (BLS) Major Indicators

Slide 18 -

Accuracy: Most economic data is compiled through surveys – larger survey pools are more accurate. To measure consumer confidence, the conference board polls 5,000 households per month. To measure prices, the bureau of labor statistics polls 28,000 retail outlets per month! (on 80,000 products) Some statistics are subject to large revisions. Housing starts are rarely revised while the monthly construction spending report often gets substantial revisions Criteria For “Good” Indicators

Slide 19 -

Timeliness The BLS employment situation report comes out a week after the end of the month, while consumer credit is reported on a two month delay. Criteria For “Good” Indicators

Slide 20 -

Predictive Ability Blue Arrow = Peak Red Arrow = Trough

Slide 21 -

Predictive Ability Blue Arrow = Peak Red Arrow = Trough

Slide 22 -

Predictive Ability Blue Arrow = Peak Red Arrow = Trough

Slide 23 -

Business Cycle Stage During recessions, we’re looking for signs of recovery Housing Starts Auto Sales Employment During expansions we tend to be more concerned with inflation CPI Employment cost index Criteria For “Good” Indicators

Slide 24 -

Who Are You? Stock markets are most concerned with consumer/business spending which drive corporate profits (Employment, Retail Sales) Bond Markets worry about inflation (CPI, PPI) Foreign Exchange Markets (Current Account, GDP, Productivity) Criteria For “Good” Indicators

Slide 25 -

Index of Leading Indicators (Conference Board) Average Hourly Workweek in Manufacturing (19.7%) Weekly Unemployment Claims (2.5%) Manufacturers’ New Orders – Consumer Goods (5.9%) Manufacturers’ New Orders – Capital Goods (1.5%) Vendor Performance (Delivery Time Index) (2.9%) Building Permits for New Homes (2%) Index of Consumer Expectations (1.9%) S&P Index (2.9%) Real (inflation adjusted) M2 Money Supply (27.7%) Interest Spread Between 10 Yr. Bonds & Fed Funds Rate (33%) A Shortcut

Slide 26 -

Index of Leading Indicators Blue Arrow = Peak Red Arrow = Trough

Slide 27 -

The Most Influential U.S. Economic Indicators

Slide 28 -

What is it: Total (Non-Farm) Employment, Unemployment Rate, Average Duration, etc…..Are people working? Release Time: 8:00AM, the first Friday of the month following the coverage month Frequency: Monthly Source: Bureau of Labor Statistics Revisions: Frequent Revisions…sometimes major! The Big One: Employment

Slide 29 -

Each month, the BLS contacts 60,000 households (95% response rate) and places each in one of four categories: Under 16 or institutionalized (or military) Choose not to work: Not in Labor Force Choose to work and are working: Employed Choose to work, but can’t find a job: Unemployed Unemployment Rate = D/(D+C) The Household Survey

Slide 30 -

US Population: 290M Civilian Population: 220M Labor Force: 147M Employment: 139M Unemployment: 8M Participation Rate (147M/220M)*100 = 66% Employment Ratio (138M/220M)*100 = 62% Unemployment Rate (8M/147M)*100 = 5.4% UR = 1 – (ER/PR) Household Survey

Slide 31 -

US Participation Rate

Slide 32 -

US Participation Rate

Slide 33 -

Each month, the BLS contacts 400,000 firms!! (60% - 70%) response rate. Each firm is asked to report total employment. Employment: 131M?? Establishment (Payroll) Survey

Slide 34 -

???

Slide 35 -

Labor markets are difficult to characterize because they are always in motion….. The US Labor Market NOT IN LABOR FORCE EMPLOYED UNEMPLOYED Average Turnover is around 2.5 Million people per Month!!

Slide 36 -

Most unemployment spells in the US are short. <5 Wks: 2.9m 5-15 Wks: 2.2m + >15 Wks: 2.9m Total: 8.0m Average duration in the US is approx. 19wks Median: 9wks Average Duration In 1 year, how many people are unemployed for 5 wks? (52/5)*2.9M = 30.1M How many people are unemployed for 10 wks? (52/10)*2.2M = 11.4M For 20 wks? +(52/20)*2.9M = 7.5M Total 49M AD = (30.1/49)*(5wks) + (11.4/49)*(10wks) + (7.5/49)*(20wks) = 8.5wks Duration

Slide 37 -

Unemployment Duration

Slide 38 -

Unemployment Duration

Slide 39 -

Frictional Unemployment: Currently unemployed, but in the process of getting a job (i.e., short term unemployment): 3.5% + Structural Unemployment (chronic unemployment): 1.5% “Natural Rate of Unemployment”: 5% Given the current unemployment rate of 5.4%, we currently have a cyclical unemployment rate of .4% What’s “Normal” in the Labor Market?

Slide 40 -

US Unemployment Rate: 1990-2002

Slide 41 -

Is the “Natural Rate” Growing?

Slide 42 -

“Capacity Output” of an economy is the level of output associated with full employment (i.e., unemployment is at the natural rate) The “output gap” is the difference between capacity output and actual output Okun’s law states that every 1% increase in cyclical unemployment increases the output gap by 2.5%. Therefore, our current .4% cyclical unemployment rate implies an output gap of 1% GPD ( Roughly $110B! ) The cost of unemployment

Slide 43 -

What is it: Current dollar value of all goods and service produced in the US Release Time: 8:30AM, The final week of the month following the covered quarter (each quarter has three estimates: Advance, Preliminary, Final) Frequency: Quarterly Source: Bureau of Economic Analysis Revisions: They usually get it right by the final revision. GDP (Gross Domestic Product)

Slide 44 -

If our economy was horizontally oriented (i.e. everyone produces final goods) economy, calculating GDP would be easy: GDP = Price*Quantity (Added up over all goods) Our economy is vertically oriented (some manufacturers produce intermediate goods). Therefore, we must avoid double counting. Each manufacturer reports output on a value added basis Calculating GDP

Slide 45 -

GDP (2003) Consumer Goods: $7,752.2B Investment Goods: $1,667.5B Government Expenditures: $2,055.7B Net Exports: -$491.5B $10,983.9 Income (2003) GDP: $10,983.9 - Net Factor Payments: $37.9 GNP: $10,946.0 Depreciation $1,370.1 NNP: $9,575.9 Indirect Taxes: $834.4 National Income: $8741.5 National Income and Product Accounts

Slide 46 -

Income (2003) GDP: $10,983.9 - Net Factor Payments: $37.9 GNP: $10,946.0 Depreciation $1,370.1 NNP: $9,575.9 Indirect Taxes: $834.4 National Income: $8741.5 Income (2003) Wages: $6,039.5 Proprietor’s Income: $774.6 Rental Income: $127.9 Corporate Profits: $1,294.2 Interest: $546.9 National Income: $8,783.1 Statistical Discrepancy: 41.6B National Income and Product Accounts

Slide 47 -

Recall that GDP will grow either because we are producing more, or because prices are increasing. To correct for this, the BEA, repeats the previous calculations using a set of “Base year” prices. GDP (2003 Prices) = $10,983.9 GDP (2000 Prices) = $10,397.2 Note that this implicitly implies a Price index……The GDP Deflator! P(2000) = 1 P(2003) = $10,983.9/$10,397.2 = 1.056 (i.e. prices increased by 5.6% from 2000 – 2003) Real vs. Nominal

Slide 48 -

GDP in 2004 is $11,649.3 Billion while GDP in 1950 was $275.7 Billion. (an increase of 4200%). Real GDP (2000 $s) in 2004 was $10,788.9 Billion while Real GDP in 1950 was $1,777.5 Billion (A 600% increase) Real GDP per capita in 2003 is $36,911 compared to $10,736 in 1950 ( a 350% increase). Median real income in 2003 is approximately $24,000 while median real income in 1950 was approximately $8,000 (a 300% increase) GDP Facts

Slide 49 -

What is it: The “Average” Price of Consumer Goods in the US Release Time: 8:30AM, The second or third week following the covered month Frequency: Monthly Source: Bureau of Labor Statistics Revisions: No Revisions except for an annual correction done in February. CPI (Consumer Price Index)

Slide 50 -

A price index is meant to capture the average price of goods and services in the economy. Therefore, any price index should be a weighted average of all (or at least, most) prices in the economy. With any fixed weight index, the weights used in the index are chosen ex ante and remain fixed over time (hence, the name fixed weight index). Think of the a fixed weight index as simply defining a “basket” of goods. The value of that index is the cost of that basket. Fixed Weight Indices

Slide 51 -

Suppose that in 2002, Apples cost $3 and Oranges cost $5. In 2003, Apples cost $4 (a 30% increase) and oranges cost $6. (20% increase) Let’s define the price index as .5( Apples) + .5(Oranges) Usually, prices are in represented in terms of a “base year”. This is done by dividing every year by the base year price P(2002) = .5($3) + .5($5) = $4. P(2003) = .5($4) + .5($6) = $5 P(2002) = 1 (or 100) P(2003) = $5/$4 = 1.25 (or 125) Example: A Fixed Weight Index

Slide 52 -

The Consumer Price Index

Slide 53 -

The inflation rate is just the percentage change in the CPI. The “core inflation rate” is the the percentage change in the CPI less energy and food prices (known to be extremely volatile) The producer price index (PPI) is the corporate analogue to the CPI The Consumer Price Index

Slide 54 -

A formal commission headed by Stanford economist Michael Boskin in 1996 determined that the CPI overestimated by as much as 2.4% per year Formula Bias: .3-.4% Substitution Bias: .2-.4% Outlet Bias: .1-.3% New Products: .2-.7% Quality Bias: .2-.6% Total: 1 - 2.4% Problems with the CPI

Slide 55 -

Variable weight indices correct for the substitution bias of the CPI by allowing the weights to vary over time. The GDP Deflator (or, more commonly, the deflator) uses actual production of each commodity as a fraction of total GDP for the weights. Therefore as production (and, hence, consumption) of a commodity rises, so does its weight in the deflator. Variable Weight Indices

Slide 56 -

During periods of large relative price changes, the choice of base year is critical for determining real growth and the behavior of prices. Chain weighting is a process by which a range of years is chosen for the “base year” and that range moves over time. Chain Weighting

Slide 57 -

What is it: A Measure of Efficiency in the Production Sector Release Time: 8:30AM, Around five weeks following the covered quarter Frequency: Quarterly Source: Bureau of Labor Statistics Revisions: Can be substantial….this depends on revisions to both GDP and Employment Productivity

Slide 58 -

Step #1: Take real GDP and subtract out government output and farm output $10,397.2 - $2,079.44 = $8,317.8 Step #2: Divide by Total Labor Hours (in the Employment Situation Report) (Employment * Average Hours *52 = Total Hours) $8,317.8/244.3 = $34/hr. Step #3: Productivity is benchmarked relative to a “base year” Suppose that Output/hr in 1992 was equal to $28.hr, then Prod(1992) = 100 Prod(2003) = 100*(34/28) = 121.4 Calculating Productivity

Slide 59 -

Y = real output N= labor hours K=capital input Y/N = Labor Productivity y – n = Labor Productivity growth (lower case letters = compound annual average rates of growth) Y = A KβN1-β = Production function (Cobb Douglas) A = Y/(KβN1-β) = Multifactor Productivity a = y – βk – (1-β)n = Growth Rate of MFP y - n = a + β (k - n) = Growth rate of labor productivity Labor and Multifactor Productivity Growth Formulas

Slide 60 -

Labor Productivity, United States, 1919-2000 1919-1929 2.27 1929-1941 2.35 1941-1948 1.71 1948-1973 2.88 1973-1989 1.33 1989-2000 1.97 1973-1995 1.40 1995-2000 2.43 Sources: 1919-48: Kendrick (1961), Table A-23. 1948-2000: Bureau of Labor Statistics: www.bls.gov

Slide 61 -

1919-1929 2.02 1929-1941 2.31 1941-1948 1.29 1948-1973 1.90 1973-1989 .34 1989-2000 .78 1973-1995 .38 1995-2000 1.14 Sources: 1919-48: Field (2003); Kendrick (1961) 1948-2000: Bureau of Labor Statistics: www.bls.gov MFP United States, 1919-2000

Slide 62 -

What is it: A Measure of how consumers feel about the economy Release Time: 10:00AM, The last Tuesday of the month being surveyed Frequency: Monthly Source: The Conference Board Revisions: Minor Consumer Confidence

Slide 63 -

The board surveys 5,000 households/month and asks the following questions: 1) How would you rate the present general business conditions in your area? Good, Normal, or Bad. 2) How about six months from now? Better, Same, Worse. 3) What would you say about available jobs in your area? Plenty, not so many, hard to get. 4) What about six months from now? Better, Same, Worse. 5) What would you guess your family income to be six months from now? Higher, same, lower. Measuring Consumer Confidence

Slide 64 -

The board surveys 5,000 households/month and asks the following questions: Step #1: For each question, the “Neutral” Response is thrown out. Step #2: The responses are transformed into a percentage Relative Response = Positive/(Positive + Negative) Step #3: The Benchmark is relative to 1985. Benchmarked Answer = Rel. Response (Current)/Relative Response(1985) Step #4: Average over the 5 questions Measuring Consumer Confidence

Slide 65 -

Example: Consumer Confidence Relative Values for 1985 are: .70, .40, .50, .60, .40 (Average = .52)

Slide 66 -

Each statistic has its strengths and weaknesses. Rarely will all the indicators “agree” with one another. Each indicator must be looked at in the context of “the big picture”. The Bottom Line