Summer 2011

1. Summer 2011 Macroeconomics Starring Erik Hurst

2. Total U.S. Non Farm Employment Since 1990

3. Unemployment Rate: 1970M1 – 2011M4

4. Unemployment Rate: 1970M1 – 2011M4 Current Unemployment Rate ~9.1%

5. Unemployment Rate: 1970M1 – 2011M4 Unemployment Falls As Recession Ends

6. Unemployment Rate: 1970M1 – 2011M4 Unemployment Does Not Fall As Recession Ends

7. Unemployment Rate: Historical

8. Broad Questions of Interest About Unemployment • What is a recession? • How can unemployment be increasing when a recession ends? • Why has the evolution of unemployment out of recessions changed over time? • Why does unemployment exist? • Can policymakers affect the unemployment rate?

9. How is Unemployment Measured? • Standardized Definition of the Unemployment Rate: Unemployed = jobless but looking for a job Labor Force = #Employed + #Unemployed Unemployment Rate = (# Unemployed) / (Labor Force) This is the definition used in most countries, including the U.S. U.S. data: http://stats.bls.gov/eag.table.html U.S. measurement details: http://stats.bls.gov/cps_htgm.htm Issues: Discouraged Workers, Underemployed, Measurement Issues • Read Course Pack Readings: 25, 28

10. Components of Unemployment • Flow of people into the unemployment pool o Flow into unemployment from employment (job loss) o Flow into unemployment from out of labor force (stop being discouraged) • Flow of people out of the unemployment pool o Flow out of unemployment into employment (job finding) o Flow out of unemployment out of labor force (discouraged workers)

11. Unemployment Duration

12. Unemployment Duration Role of Unemployment Benefit Extension?

13. Types of Unemployment • Frictional Unemployment: Result of Matching Behavior between Firms and Workers. • Structural Unemployment: Result of Mismatch of Skills and Employer Needs Article of interest: 2 Million 'Open Jobs'? Yes, But U.S. Has Skills Mismatch (NPR.org) • Cyclical Unemployment: Result of output being below full-employment. Individuals have the desire to work and the skills to work, yet cannot find a job. • Is Zero Unemployment a Reasonable Policy Goal? • No! Frictional and Structural Unemployment may be desirable (unavoidable).

14. Why is the Distinction Important? • How much of the current unemployment is structural vs. cyclical? • This is a current debate among policy makers (and a question I am trying to answer in my own research) • Why could there be structural unemployment? o Some industries boomed inefficiently during the early 2000s (construction) and need to retrench. The jobs being created now are not in those industries (where unemployment is high). o Some states boomed inefficiently during the early 2000s (Nevada, Florida, California, Arizona, etc.) and need to retrench. The jobs being created now are not in those states (where unemployment is high)

15. Spatial Variation in Unemployment Rate (March 2011)

16. Construction, Finance, Real Estate Share of Employment

17. House Price Growth (00-06) and Change in Construction Labor Share (00-06) Construction Share from American Community Survey (ACS) – Prime Age Men (Out of All Men in Labor Force) (R-squared=0.44)

18. Change in Construction Share (01-06) vs. Total Employment Growth (01-06) All Data from BEA Employment Data (R-squared=0.46)

19. Change in Construction Share (01-06) vs Total Employment Growth (08-10) All Data from BEA Employment Data (R-squared=0.45)

20. Change in Construction Share (01-06) vs Population Growth (00-06) Construction Share Data from BEA Employment Data (R-squared=0.40)

21. Unemployment Rate Change (06-10) by House Price Growth Quintile (00-06) Unemployment Rate: BLS Statistics

22. Change in Construction Labor Share (01-06) vs. Share of Unemployment Coming From Construction (2009)(09) Unemployment Share from ACS (R-squared=0.34)

23. Why We Care About Unemployment • Depreciation of Human Capital • Productive Externalities • Social Externalities • Individual Self Worth

24. Questions We Will Address In This Course • What causes recessions? What causes unemployment? • What caused this recession? Will there be a double dip? • What is the link between housing prices and “real” economic activity (consumption, production, unemployment, etc.)? • What is the link between the banking sector and “real” economic activity? • Should we be concerned with inflation? What about deflation? • What causes inflation/deflation? • How can policy makers (Fed/Congress/President) influence economic activity in the short run (fight inflation and recessions) and in the long run (promote economic growth)? • What are the pitfalls of government intervention? • What makes economies grow in the LONG RUN?! • How worried should we be about long run government deficits? • What are the costs/benefits of altering the nature of the Federal Reserve? • What is the influence of China and India on the U.S. economy?

25. Caveat #1 • My course takes the perspective of analyzing any large macroeconomy (with respect to the models we build). • The examples will come from the U.S. (because that is what I study) • However, the insights apply equally well to all large developed economies including: • The European Union • Japan • Canada, Australia, etc. (for the most part). • The models also explains well consumer, business, and government behavior for all economies (China, India, etc.).

26. Caveat #2 • The course takes time to build. • Our goal is to construct and analyze the economy as a whole. • To do that, we separately build the parts. • After we build the parts, we put them together to see how they interact. • At certain points in the class, you may feel that we are losing sight of the big picture and you may yourself feel lost. That is common. • But, I promise, by week 7 or 8 everything will come together (it always does).

27. TOPIC 1 A Introduction to Macro Data

28. Goals of the Lecture What is Gross Domestic Product (GDP)? Why do we care about it? How do we measure standard of living over time? What are the definitions of the major economic expenditure components? What are the trends in these components over time? What is the difference between ‘Real’ and ‘Nominal’ variables? How is Inflation measured? Why do we care about Inflation? What have been the predominant relationships between Inflation and GDP over the last four decades? NOTE: This lecture will likely go into next week. This is by design. It does not mean we will be short-changed on other material later in the class.

29. Gross Domestic Product (GDP) • GDP is a measure of output! • Why Do We Care? • Because output is highly correlated (at certain times) with things we care about (standard of living, wages, unemployment, inflation, budget and trade deficits, value of currency, etc…) • Formal Definition: • GDP is the MarketValue of all FinalGoods and Services Newly Produced on DomesticSoil During a Given TimePeriod (different than GNP)

30. “Production” Equals “Expenditure” • GDP is a measure of Market Production! • GDP = Expenditure = Income = Y (the symbol we will use) (in macroeconomic equilibrium) • What is produced in the market has to be show up as being purchased or held by some economic agent; • Who are the economic agents we will consider on the expenditure side? • Consumers (refer to expenditure of consumers as “consumption”) • Businesses (refer to expenditure of firms as “investment”) • Governments (refer to expenditures of governments as “government spending”) • Foreign Sector (refer to expenditures of foreign sector as “exports”)

31. A Simple Example • What is “produced” has to be “purchased” by someone (including the producer). • Suppose I produce silverware (forks, spoons, etc.). If so, I could: • sell it to some domestic customer (Consumption) • sell it some business (Investment) • keep it in my stock room as inventory (Investment) • sell it to the city of Chicago to use in their shelters (Government spending) • sell it to some foreign customer (Export)

32. “Production” Equals “Income” • What is Produced is Also a Measure of Income. • If you pay a $1 for something, that $1 has to end up in someone’s pocket as: Wages/Salary (compensation for workers who make production) Profits (compensation for self employed) Rents (compensation for land owners) Interest (compensation for debt owners) Dividends (compensation for equity owners) • Notice, wages are only one component of income (Y does not equal wages)! (Although, under certain production functions, they will be proportional to each other).

33. Stop and Pause • By definition….. Production = Income = Expenditure = Y • What is produced has to be purchased by someone (accounting for inventory changes). • What is purchased has to end up as income in somebody’s pocket! • In our class, we realize that the terms are interchangeable in equilibrium.

34. Measuring GDP in Practice • Production Method: Measure the Value Added summed Across Industries (value added = sale price - cost of raw materials) • Expenditure Method: Spending by consumers (C) + Spending by businesses (I) + Spending by government (G) + Net Spending by foreign sector (NX) • Income Method: Labor Income (wages/salary) + Capital Income (rent, interest, dividends, profits). • In our class, we will model the production side of economy (supply side) and the expenditure side of the economy (demand side). • Prices will always adjust to equate supply and demand such that Y (production) always equals Y (expenditure).

35. What GDP is NOT! • GDP is not, or never claims to be, an absolute measure of well-being! • Size effects : But even GDP per capita is not a perfect measure of welfare • “The gross national product does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud to be Americans.” • U.S. Senator Robert F. Kennedy, 1968

36. More on What GDP Is Not • GDP Does Not Measure: • Non-Market Activity (home production, leisure, black market activity) • Environmental Quality/Natural Resource Depletion • Life Expectancy and Health • Income Distribution • Crime/Safety • Remember how we measure GDP…(i.e., how does one measure “safety”). • Ideally, what we would like to measure is quality of one’s life: • Present discounted value of utility from one’s own consumption and leisure and that of one’s loved ones. • Read: Course Pack Readings 22-24 and 26

37. Defining the Expenditure Components (formally) • Consumption (C): • The Sum of Durables, Non-Durables and Services Purchased Domestically by Non-Businesses and Non-Governments (ie, individual consumers). • Includes Haircuts (services), Refrigerators (durables), and Apples (non-durables). • Does Not Include Purchases of New Housing. • Investment (I): • The Sum of Durables, Non-Durables and Services Purchased Domestically by Businesses • Includes Business and ResidentialStructures, Equipment and Inventory Investment • Land purchases are NOT counted as part of GDP (land is not produced!!) • Stock purchases are NOT counted as part of GDP (stock transactions do NOT represent production – they are saving!) There is a difference between financial and economic investment!!!!!!!

38. More On Expenditure/Production Components • Government Spending (G): Goods and Services Purchased by the domestic government. • For the U.S., 2/3 of this is at the state level (police and fire protection, school teachers, snow plowing) and 1/3 is at the federal level (President, Post Office, Missiles). • NOTE: Welfare and Social Security are NOT Government Spending. These are Transfer Payments. Nothing is Produced in this Case. • Net Exports (NX): Exports (X) - Imports (IM); • Exports: The Amount of Domestically Produced Goods Sold on Foreign Soil • Imports: The Amount of Goods Produced on Foreign Soil Purchased Domestically.

39. Summary of the Demand Side of Economy • Expenditures: Y = C + I + G + X - IM • Only four economic agents can “spend” on domestic production Domestic consumers (C) Domestic firms (I) Domestic governments (G) Foreign consumers, firms, and governments (X) • We will develop models for each sub component of the expenditure side of the economy (C, I, G, and NX).

40. Measuring Expenditure (Demand Side) • Only include expenditures for goods that are “produced”. • If I give $10 to a movie theater to watch a movie, it is counted as expenditure. • If I give $10 to my nephew for a birthday present, it is not counted as expenditure. • If I give $10 to the ATM machine to put in my savings account, it is not counted as expenditure. • The second example would be considered a “transfer” (once I give $10 to my nephew, he can go to the movies if he wanted to – once that $10 is spent, it will show up in GDP). • “Transfers” are defined as the exchange of economic resources from one economic agent to another when no goods or services are exchanged. • The third example is considered “saving” (I am delaying expenditure until the future). Once I spend the $10 in the future, it will show up in GDP.

41. Some Examples of GDP Calculations • Thinking about imports Y = C + I + G + X – IM • Thinking about inventories (storing production….) Y = C + I + G + X – IM • Distinguishing between government spending and “transfers”. Y = C + I + G + X – IM

42. Summary of Supply Side of Economy • Production: Y = f(A, N, K, other inputs like oil) where A = technology, N = labor input, K = capital (machine) input • We will develop models/intuition for A, N, K and oil • N will be determined in the labor market (labor demand and labor supply)

43. Where We are Headed

44. The role of “prices” • “Prices” ensure that we are always in equilibrium • 4 prices in our class Price of output (CPI) P Price of labor (real wages) W/P Price of money (loans – real interest rates) r Price of foreign currency (exchange rate) $ or e • We will develop (from fundamentals) 4 markets in our class

45. The 4 Markets 1) Labor Demand vs. Labor Supply (determines N and W/P) Necessary to compute the supply side of economy Key to where recessions come from (frictions in the labor market) 2) IS-LM market (determines r and Y (via I)) Interest rates determine firm investment Key to federal reserve policy (sets r) Key to understanding banking crises. 3) Aggregate Demand vs. Aggregate Supply (determines P and Y) Key to understanding where inflation comes from!

46. The 4 Markets (continued) 4) Foreign Exchange Market (determines value of currency and NX) We will focus on this market in week 10 Notice, markets 1-3 help to pin down the level of Y in the economy These four markets (and their components) will determine everything we want to know about the macroeconomy (production, inflation, economic growth, unemployment, interest rates, budget deficits, trade deficits, etc.) For the next 7 weeks, we will build the underpinnings of these markets. In doing so, we will uncover how these markets work and what factors influence those markets!

47. An Important Equation

48. Defining Savings (Store this Away!) Yd = Disposable Income = Y - T + Tr (1) • T = Taxes • Tr = Transfers (ie, Welfare) Yd = C + SHH (2) • SHH = Personal (Household or Private) Saving SHH = Y - T + Tr – C <<Combine (1) and (2)>> (3) • Personal Savings Rate = SHH/Yd For simplicity, we are going to abstract from business saving (things like retained earnings and depreciation). For those interested in more of these accounting relationships, see the text.

49. A Look at Actual U.S. Household Saving Rates: 1970Q1 – 2009Q3 Note: Shaded areas are recessions.

50. Saving Identities (continued) Sgovt = T - (G + Tr) (4) • Sgovt = Government (Public) Saving • Includes Federal, State and Local Saving • What government collects (T) less what they pay out (G and Tr) S = SHH + Sgovt = Y - C - G = I + NX (5) • S = National Savings so, S = Y - C – G <<Combine (3) and (5)>> (6) S = I + NX <<Combine (6) and Y = C+I+G+NX>> (7)