Lecture 1 A look at the data. Stylized facts on growths

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1 Lecture 1 A look at the data. Stylized facts on growths Beatriz de Blas Universidad Autónoma de Madrid September 2012 B. de Blas (UAM) DynMac - Lesson 1 September / 37

2 Outline 1. Introduction 2. International data comparisons 3. Is there any convergence? 4. Empirical regularities about economic growth 5. Business cycles 6. Stylized facts of business cycles 7. Explaining business cycles 8. The role of money in business cycles B. de Blas (UAM) DynMac - Lesson 1 September / 37

3 Density of coutries Figure: Distribution of PPP-adjusted GDP per capita. Figure: Distribution of PPP-adjusted GDP per capita. B. de Blas (UAM) DynMac - Lesson 1 September / Economic growth Cross-country income differences ross-country Income Di erences Cross-country income differences There are arevery verylarge largedi erences differencesin income per capitaand and outputper per worker worker across countries today gdp per capita

4 1. Economic growth Cross-country income differences Cross-country income differences Part of the spreading out of the distribution in the Figure is because of the increase in average incomes. More natural to look at the log of income per capita when growth is approximately proportional: when x(t) grows at a proportional rate, log x(t) grows linearly, if x 1 (t) and x 2 (t) both grow by 10%, x 1 (t) x 2 (t) will also grow, while log x1 (t) log x 2 (t) will remain constant. The next Figure shows a similar pattern, but now the spreading-out is more limited. B. de Blas (UAM) DynMac - Lesson 1 September / 37

5 Density of coutries 1. Economic growth Cross-country income differences Growth and Development: The Questions Cross-Country Income Di erences Cross-country Cross-Countryincome Incomedifferences Di erences log gdp per capita Figure: Estimates Estimates of the of the distribution distribution of countries of countries according according to log GDP to log per GDP capita (PPP-adjusted) per capita in 1960, (PPP-adjusted) 1980 and in 1960, 1980 and Daron Acemoglu (MIT) Economic Growth Lecture 1 October 26, / 55 B. de Blas (UAM) DynMac - Lesson 1 September / 37

6 1. Economic growth Cross-country income differences Cross-country income differences Theory is easier to map to data when we look at output (GDP) per worker. National policies and institutions: key sources of difference in economic performance across countries. The next Figure looks at the unweighted distribution of countries according to (PPP-adjusted) GDP per worker workers : total economically active population according to the definition of the International Labor Organization. Overall, two important facts: 1. Large amount of inequality in income per capita and income per worker across countries. 2. Slight but noticeable increase in inequality across nations (though not necessarily across individuals in the entire world). B. de Blas (UAM) DynMac - Lesson 1 September / 37

7 Density of coutries 1. Economic growth Cross-country income differences Growth and Development: The Questions Cross-Country Income Di erences Cross-country income differences Cross-Country Income Di erences log gdp per worker Figure: Figure: Distribution Distribution of of log loggdp per perworker worker (PPP-adjusted). (PPP-adjusted). Daron Acemoglu (MIT) Economic Growth Lecture 1 October 26, / 55 B. de Blas (UAM) DynMac - Lesson 1 September / 37

8 log gdp per capita 1. Economic growth Economic growth and income differences Growth and Development: The Questions Economic Growth and Income Di erences Economic growth and income differences Economic Growth and Income Di erences USA UK Spain Brazil South Korea Singapore Guatemala Botswana India Nigeria year Figure: The evolution of income per capita Figure: The evolution of income per capita Daron Acemoglu (MIT) Economic Growth Lecture 1 October 26, / 55 B. de Blas (UAM) DynMac - Lesson 1 September / 37

9 1. Economic growth Economic growth and income differences Economic growth and income differences - Questions Why is the United States richer in 1960 than other nations and able to grow at a steady pace thereafter? How did Singapore, South Korea and Botswana manage to grow at a relatively rapid pace for 40 years? Why did Spain grow relatively rapidly for about 20 years, but then slow down? Why did Brazil and Guatemala stagnate during the 1980s? What is responsible for the disastrous growth performance of Nigeria? Our first task is to develop a coherent framework to investigate these questions and as a byproduct we will introduce the workhorse models of dynamic economic analysis and macroeconomics. B. de Blas (UAM) DynMac - Lesson 1 September / 37

10 2. International data comparisons 2. International data comparisons There are very large differences in income per capita across countries today. Are we making the appropriate comparisons? Is it possible that income in low-developed countries is missmeasured? bad statistics self-consumption B. de Blas (UAM) DynMac - Lesson 1 September / 37

11 2. International data comparisons Exchange rates International comparisons: exchange rates These numbers are all in 2000 U.S. dollars and are adjusted for purchasing power parity (PPP) to allow for differences in relative prices of different goods across countries. The cross-country income gap is considerably larger when there is no PPP adjustment. For example, without the PPP adjustment, GDP per capita in India and China relative to the United States in 2000 would be lower by a factor of four or so. B. de Blas (UAM) DynMac - Lesson 1 September / 37

12 2. International data comparisons PPP adjustment International comparisons: PPP adjustment Much of the data used here come from Summers-Heston s (Penn World Tables) dataset (latest version, Summers, Heston, and Aten, 2006). PPP adjustment is made possible by these data. PPP adjustment enables the construction of measures of income per capita that are comparable across countries. Procedure: Construct international prices of a weighted average of prices (in $) of basket of goods and services across different countries. Estimate national income using international prices. B. de Blas (UAM) DynMac - Lesson 1 September / 37

13 2. International data comparisons PPP adjustment International comparisons: PPP adjustment Without PPP adjustment, differences in income per capita across countries can be computed using the current exchange rate or some fundamental exchange rate. Problem with such exchange rate based measures This method of international prices works better for tradable goods. The most important one is that they do not allow for the marked differences in relative prices and even overall price levels across countries. PPP adjustment brings us much closer to differences in real income and real consumption. B. de Blas (UAM) DynMac - Lesson 1 September / 37

14 2. International data comparisons Economic growth and income differences Economic growth and income differences Real GDP growth constant and positive: Y t = Y 0 (1 + g) t How would it look like in the space (Y t, t)? Is it possible to know from this graph if the growth rate is constant over time? Is the average growth rate constant, increasing or decreasing? Solution: log scale Rule of 70: provides this information, small differences imply quite alike results how long it takes for income levels to double only depends on growth rates, not on levels if growth is measured annually ( then a 1% growth ) rate results in a doubling every 70 years log % 70 1 = 70yrs B. de Blas (UAM) DynMac - Lesson 1 September / 37

15 3. Is there any convergence? 3.Is there any convergence? Until now: comparisons of income gaps based on unconditional distributions. Barro and Sala-i-Martin (1991,1992,2004): better to look at conditional distributions. Q: is the income gap between two countries that are similar in observable characteristics becoming narrower or wider over time? conditional convergence Fact: in the postwar period, the income gap between countries that share the same characteristics typically closes over time (though it does so quite slowly) No evidence of (unconditional) convergence in the world income distribution over the postwar era (some divergence) But some evidence for conditional convergence, i.e. the income gap between countries that are similar in observable characteristics appears to narrow over time. B. de Blas (UAM) DynMac - Lesson 1 September / 37

16 4. Stylized facts of growth 4. Stylized facts of growth Economic growth rates vary substantially across countries: growth miracles versus disasters. (E.g.: China, Africa) Growth rates are not necessarily constant over time. (E.g.: China, Japan) A country s relative position in the distribution of world income per capita is not static. Countries can move from poor to rich and vice versa. (E.g.: South Korea, Argentina) Sustained increase in per capita income levels since mid-19th century in countries which are considered developed today. Transition towards a balanced growth path associated with strong changes in population growth rates. There seems to be a negative relationship between per capita income and population growth over development n is endogenous. B. de Blas (UAM) DynMac - Lesson 1 September / 37

17 4. Stylized facts of growth Empirical regularities about economic growth (Kaldor, 1963) 1. Per capita output grows over time, and its growth rate does not tend to diminish. 2. Physical capital per worker grows over time. 3. The rate of return to capital is nearly constant. 4. The ratio of physical capital to output is nearly constant. 5. The shares of labor and physical capital in national income are nearly constant. 6. The growth rate of output per worker differs substantially across countries. B. de Blas (UAM) DynMac - Lesson 1 September / 37

18 5. Business cycles 5. Business cycles What are business cycles? Why are we interested in business cycles? B. de Blas (UAM) DynMac - Lesson 1 September / 37

19 5. Business cycles Business cycles definition Business cycles definition Business cycles are a type of fluctuation found in the aggregate economic activity of nations that organize their work mainly in business enterprises: a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions, and revivals which merge into the expansion phase of the next cycle. This sequence of changes is recurrent but not periodic; in duration business cycles vary from more than one year to ten or twelve years; they are not divisible onto shorter cycles of similar character with amplitudes approximating their own. (Burns y Mitchell, 1946) B. de Blas (UAM) DynMac - Lesson 1 September / 37

20 5. Business cycles Business cycles definition Key points: 1. Aggregate economic activity. 2. Expansions and contractions. 3. Joint movements of economic variables. 4. Recurrent but not periodic. 5. Cycle persistence. Duration. B. de Blas (UAM) DynMac - Lesson 1 September / 37

21 5. Business cycles Dating of Business cycle Dating of business cycles A. Burns & W. Mitchell (1946) identified and analyzed what we understand today for business cycle. Key aspect: Several economic indicators move jointly. Key dates in business cycles: Peak: The last month before some key indicators start falling. Trough: The last month before the same indicators star growing. Problem: Sometimes, key economic indicators, change their direction in different moments Business cycles are difficult to measure. They are not regular economic fluctuations It does not need to happen, but it happens. B. de Blas (UAM) DynMac - Lesson 1 September / 37

22 5. Business cycles Dating of Business cycle Dating business cycles General definition of a recession: Two consecutive quarters of fall in real GDP When are there recessions and expansions? In U.S.A.: National Bureau of Economic Research (slightly different definition) (NBER) In Europe (?) Some organizations: CEPR, eabcn, Eurostat, BCE,... B. de Blas (UAM) DynMac - Lesson 1 September / 37

23 Measuring business cycles Measuring business cycles: an example RAW _ GDP LGDP HP_ L GDP DL GDP B. de Blas (UAM) DynMac - Lesson 1 September / 37

24 Measuring business cycles The business cycle DLGDP B. de Blas (UAM) DynMac - Lesson 1 September / 37

25 Measuring business cycles The representation of a variable cycle and trend Representation of a variable: cycle and trend Any observed time series, y t, can be decomposed: a growth component (or trend), τ t, a cyclical component (or deviation from trend), d t. That is, y t = τ t + d t. B. de Blas (UAM) DynMac - Lesson 1 September / 37

26 Measuring business cycles The representation of a variable cycle and trend There are many ways of extracting the cyclical component of a time series: Statistical decompositions: lineal trend: τt = α + βt d t = y t α OLS β OLS t random walk trend: τt = τ t 1 + ε t y t = d t + ε t... Hybrid decompositions: Hodrick-Prescott filter Moving average filter (band pass filter) Exponential smoothing filter Economic decompositions (based on VARs) B. de Blas (UAM) DynMac - Lesson 1 September / 37

27 Measuring business cycles The representation of a variable cycle and trend How to extract cyclical information Which statistics should we use? Average ratios (growth theory) Standard deviations, autocorrelations and correlations (business cycles) Which filter should we choose? Canova (JME1998; EER1994) B. de Blas (UAM) DynMac - Lesson 1 September / 37

28 6. Stylized facts of business cycles The cyclical behavior and temporal coincidence Cyclical behavior of economic variables and its temporal coincidence Cyclical behavior: procyclical (ρ(dx,t, d y,t ) positive and significant), countercyclical (ρ(dx,t, d y,t ) negative and significant), acyclical (ρ(dx,t, d y,t ) close to 0). Temporal coincidence: leading: ρ(dx,t, d y,t ) > 0 but ρ(d x,t 1, d y,t ) > ρ(d x,t, d y,t ), the variable reacts before the cycle, lagging: ρ(dx,t, d y,t ) > 0 but ρ(d x,t+1, d y,t ) > ρ(d x,t, d y,t ), the variable reacts with a delay with respect to the cycle, coincident: ρ(dx,t, d y,t ) > 0 but ρ(d x,t, d y,t ) > ρ(d x,t 1, d y,t ) and ρ(d x,t, d y,t ) > ρ(d x,t+1, d y,t ), both variables move at the same time. B. de Blas (UAM) DynMac - Lesson 1 September / 37

29 6. Stylized facts of business cycles The cyclical behavior and temporal coincidence Cyclical behavior of key economic variables Variable Comovement Time-reaction Production (Y ) Industrial P. Procyclical Coincident Expenditure (C + I + G) Consumption (C) Procyclical Coincident Gross fixed capital formation Procyclical Coincident Residential investment Procyclical In advance Inventory investments Procyclical In advance Government expenditures (G) Procyclical Labour market Employment Procyclical Coincident Unemployment Countercyclical Labor productivity Procyclical In advance Real wage Procyclical B. de Blas (UAM) DynMac - Lesson 1 September / 37

30 6. Stylized facts of business cycles Example-1: U.S.A. Cyclical behavior of the U.S. economy (1964:I-2009:II). Standard GDP correlation with Variable x(t) deviation (%) x(t 1) x(t) x(t + 1) Gross national product Consumption - Non durable goods and services Durable goods Investment Gross fixed capital formation Residential Inventory* Worked hours Employment Lab. productivity (GNP/Hours) Average worked hours Wages Government expenditures Source: Own elaboration from St. Louis Federal Reserve (FRED) data. *Ratio of inventory changes over GDP. B. de Blas (UAM) DynMac - Lesson 1 September / 37

31 6. Stylized facts of business cycles Example-1: U.S.A. Stylized facts of business cycles Some regularities (stylized facts) employment, very procyclical non-durable goods consumption and services procyclical and not very volatile inventory investment very volatile and procyclical durable goods consumption and Gross Fixed Capital Formation, procyclical and very volatile durable goods consumption more volatile than non-durable and services productivity, slightly procyclical but less volatile than GDP wages less volatile than labor productivity B. de Blas (UAM) DynMac - Lesson 1 September / 37

32 6. Stylized facts of business cycles Example-1: U.S.A. More stylized facts... output and hours worked fluctuate more or less the same employment fluctuates as much as production, but average weekly hours worked fluctuates much less non-durable goods consumption and services fluctuate much less than output investment in both, capital formation and durable consumption goods, fluctuate much more than output capital stock fluctuates much less than output and has a low correlation with GDP labor productivity is slightly procyclical but fluctuant much less than GDP wages fluctuatef less than labor productivity. government expenditures not correlated with GDP. B. de Blas (UAM) DynMac - Lesson 1 September / 37

33 7. Explaining business cycles 7. Explaining business cycles Keynesian or neo-keynesian approach: cycles are the result of economic imperfections. fiscal policy shocks can generate cycles monetary policy shocks can too conclusion: cycles are costly Neo-classical approach: modern industrial economies are quite flexible and adjust themselves to new situations productivity and preferences shocks conclusion: recessions are not bad in itself If fiscal and monetary policies cause cycles, and they ar costly, what can be done to prevent them? Why have not we been succesfull preventing business cycles? B. de Blas (UAM) DynMac - Lesson 1 September / 37

34 8. The role of money in business cycles 8. The role of money in business cycles 1. Long run (McCandless & Weber, 1995) Objective: to study long run monetary relationships, data for 110 countries during 30 years. Conclusions: correlation between inflation and money growth rate is almost 1 (consistent with quantitative theory of money), no correlation between inflation or money growth rate and output. B. de Blas (UAM) DynMac - Lesson 1 September / 37

35 8. The role of money in business cycles 2. Short run (Cooley & Hansen, 1998) Chart 1: Standard deviations of some macroeconomic variables (US) Chart 2: GDP correlation with nominal variables Debate: changes in the amount of money implies product fluctuations? money endogeneity Consensus: In the short run, exogenous changes in the amount of money cause changes in the reversed U-shape of production, reaching the maximum some quarters after. Approaches: VAR (Sims, 1992; Leeper, Sims y Zha, 1996) Narrative (Romer y Romer, 1989) Studies about inflation reduction processes (Sargent,1986). B. de Blas (UAM) DynMac - Lesson 1 September / 37

36 8. The role of money in business cycles Chart 1: Standard deviations of some macroeconomic variables (US) 1954:3-1994:4 54:3-79:3 82:4-94:4 Real GDP M1 (growth rate) Hours C (non-dur & serv.) Investment Lab. productivity CPI GDP deflator Inflation (CPI) Int. rate (FFR) m-Tbill rate yr-Tbill rate Velocity (GDP/M1) Source: Own ellaboration from Cooley y Hansen data (1998). Values calculated from HP-filtered data. B. de Blas (UAM) DynMac - Lesson 1 September / 37

37 8. The role of money in business cycles Chart 2: GDP correlation with nominal variables 1954:3-1994:4 54:3-79:3 82:4-94:4 M1 (t. ccto) CPI GDP deflator Inflation (IPC) FFR Tdi 3m Tdi 10a Speed (PIB/M1) Source: Own production from Cooley y Hansen data (1998). Values calculated from HP-filtered data. B. de Blas (UAM) DynMac - Lesson 1 September / 37