Main macroeconomic

indicators
Goran Jovicic, MSc, FRM
 Introduction

➢ In this lecture we are going to talk about the main macroeconomic indicators, how they
are defined and used. Also, we are going to shortly discuss potential problems in their
construction and interpretation.

➢ But before that we should probably say something a bit about what exactly is
macroeconomics and why it is important to study it.
 What is macroeconomics?
➢ Macroeconomics is the branch of
economics that deals with the structure, The paradox of thrift (or paradox of saving) is
performance, behavior, and decision- a paradox of economics. The paradox states that an increase
in autonomous saving leads to a decrease in aggregate
making of the whole, or aggregate, demand and thus a decrease in gross output which will in
economy. The two main areas of turn lower total saving. The paradox is, narrowly speaking,
macroeconomic research are long-term that total saving may fall because of individuals' attempts to
increase their saving, and, broadly speaking, that increase in
economic growth and shorter-term
saving may be harmful to an economy.
business cycles.
The paradox of thrift is an example of the fallacy of
➢ Unlike microeconomics which studies composition, the idea that what is true of the parts must
always be true of the whole. The narrow claim transparently
how individual economic actors, such as contradicts the fallacy, and the broad one does so by
consumers and firms, make decision - implication, because while individual thrift is generally
macroeconomics concerns itself with averred to be good for the individual, the paradox of thrift
holds that collective thrift may be bad for the economy.
the aggregate outcomes of those
decisions.
Circular flow of the economy
 Importance of macroeconomics
➢ Macroeconomics addresses many topical issues. For example:

• What causes recessions? Can the government do anything to combat recessions?

Should it?
• What is the government budget deficit? How does it affect the economy?
• Why are millions of people unemployed?
• Why does the cost of living keep rising?
• Why are so many countries poor? What policies might help them grow out of poverty?

➢ Three major macroeconomic objectives:

✓ High, but sustainable, rate of economic growth

✓ Price stability
✓ Full employment
 Main macroeconomic indicators

➢ Economists use many types of indicators to measure the performance of an economy.

Three macroeconomic variables are especially important:

• Gross domestic product (GDP)

• Unemployment rate
• Inflation rate

➢ Beside these exchange rates, interest rates and other financial market data like stock
prices also play a prominent role and we are going to say something about them later
in the course.
 Gross domestic product (GDP)

➢ Economists studying economic activity in the nineteenth century or during the Great
Depression had no measure of aggregate activity (aggregate is the word
macroeconomists use for total) on which to rely. They had to put together bits and
pieces of information, such as the shipments of iron ore, or sales at some department
stores, to try to infer what was happening to the economy as a whole.

➢ It was not until the end of World War II that national income and product accounts
(or national income accounts, for short) were put together. Measures of aggregate
output have been published on a regular basis in the United States since October
1947.
 Gross domestic product (GDP)
➢ The measure of aggregate output in the national income accounts is called the gross
domestic product, or GDP, for short. To understand how GDP is constructed, it is best to work
with a simple example. Consider an economy composed of just two firms:

Firm 1 produces steel, employing workers and using machines to produce the steel. It sells the steel for $100
to Firm 2, which produces cars. Firm 1 pays its workers $80, leaving $20 in profit to the firm.

Firm 2 buys the steel and uses it, together with workers and machines, to produce cars. Revenues from car
sales are $200. Of the $200, $100 goes to pay for steel and $70 goes to workers in the firm, leaving $30 in
profit to the firm.
 Gross domestic product (GDP)
➢ GDP is the value of the final goods and services produced in the economy during
a given period - the important word here is final. We want to count only the production
of final goods, not intermediate goods.

➢ GDP is the sum of aggregate expenditures - by expenditures we mean can be

viewed as the sum of personal consumption expenditures (C), intended business
investment expenditures plus unintended changes in business inventories (I),
government expenditures on final products (G), and net export (NX) expenditures.

➢ GDP is the sum of value added in the economy during a given period - the term
value added means exactly what it suggests. The value added by a firm is defined as
the value of its production minus the value of the intermediate goods used in production.

➢ GDP is the sum of incomes in the economy during a given period – by incomes
here we mean labor income, rent income, interest income and profits.
 Nominal and real GDP
➢ Nominal GDP is the sum of the quantities of final
goods produced times their current price. This
definition makes clear that nominal GDP increases
over time for two reasons:

• the production of most goods increases over time

• the price of most goods also increases over time

➢ If our goal is to measure production and its change

over time, we need to eliminate the effect of increasing
prices on our measure of GDP. That’s why real GDP
is constructed as the sum of the quantities of final
goods times constant (rather than current) prices.
 Nominal and real GDP

➢ Consider an economy that only produces cars and assume the same model is
produced every year. Suppose the number and the price of cars in three successive
years. Table below gives an example of nominal and real GDP calculations:

➢ The problem when constructing real GDP in practice is that there is obviously
more than one final good. Real GDP must be defined as a weighted average of
the output of all final goods, and this brings us to what the weights should be - in
practice income accounts use weights that reflect relative prices and which
change over time.
 GDP level vs GDP growth rate
➢ The level of real GDP is important number an
important number that gives the economic size of a
country. A country with twice the GDP of another
country is economically twice as big as the other
country.

➢ Equally important is the level of real GDP per

person, the ratio of real GDP to the population of
the country. It gives us the average standard of
living of the country.

➢ In assessing the performance of the economy from

year to year, economists focus, however, on the
rate of growth of real GDP, often called just GDP
growth. There is a huge difference between year-on-year and quarter-on-
quarter growth rates. Always take that into account and be careful
when you are reading media reports or search for the data!
 GDP and business cycles

➢ Business cycles are “recurring, irregular, and

unsystematic movements in real economic activity
around a long-term trend

➢ Recessions are significant contractions in

economic activity, which are spread broadly across
an economy and last for more than a few months.
Expansions (also called recoveries) are just the
opposite

➢ In the news media, a nation is often said to be in a

“recession” when its real GDP falls for two
consecutive quarters, but, officially, recessions are
not measured or dated this way. Rather, a
spectrum of macroeconomic variables is used to
Positive Output Gap: GDP above potential GDP gauge a nation’s economic health
Negative Output Gap: GDP below potential GDP
 Unemployment rate
➢ A nation’s unemployment rate equals the
number of individuals who are unemployed
divided by the civilian labor force.

➢ The employment rate measures the

number of people employed divided by the
civilian non-institutional population 16+.
Therefore, an unemployment rate of 6
percent does not mean the employment
rate is 94 percent.

➢ The labor force participation rate measures

the civilian labor force divided by the
civilian non-institutional population 16+ This
measure is particularly important to nations
where workers have dropped out of the
labor force - often due to job
discouragement and the lack of
opportunities.
 Unemployment rate
➢ Confusion and misunderstanding often arise in discussions about a nation’s unemployment
rate and for good reason:

➢ Only individuals who are actively seeking work are counted as unemployed, which means that if
someone tries to find work and then gives up in frustration, the unemployment rate falls.

➢ Unemployment figures do not account for differences in family situations. As a result, the loss of a job
by a single income earner (e.g. mother or father) in a family of four is counted the same as the loss of
job by a live-at-home high school student in a family of four, where the other three family members are
fully employed.

➢ The unemployment rate is not adjusted for underemployment, which occurs when individuals are
working in occupations below their abilities,training, or skill levels.

➢ The unemployment rate tends to lag behind economic activity. As a result, it is not a good reflection of
current economic conditions.
 Why we care about unemployment ?
➢ Unemployment has direct effect on the welfare of The figure plots the average life satisfaction for those individuals who were
the unemployed. Although unemployment benefits unemployed during one year, and employed in the four years before and in the
four years after. Year 0 is the year of unemployment. Years -1 to -4 are the years
are more generous today than they were during
before unemployment, years 1 to 4 the years after.
the Great Depression, unemployment is still often
associated with financial and psychological
suffering.

➢ Unemployment rate because it provides a signal

that the economy may not be using some of its
resources. When unemployment is high, many
workers who want to work do not find jobs; the
economy is clearly not using its human resources
efficiently.

➢ What about when unemployment is low? Can very

low unemployment also be a problem? The
answer is yes. Like an engine running at too high a
speed, an economy in which unemployment is
“Unemployment and happiness,” by Rainer Winkelmann, IZA world of labor, 2014: 94
very low may be overusing its resources and run
into labor shortages.
 Inflation
➢ Inflation is a sustained rise in the general
level of prices - the price level. The
inflation rate is the rate at which the price
level increases. Symmetrically, deflation is
a sustained decline in the price level. It
corresponds to a negative inflation rate.).

➢ The practical issue is how to define the

price level so the inflation rate can be
measured. Macroeconomists typically look
at two main measures of the price level, at
two price indexes: the GDP deflator and
the Consumer Price Index (CPI).
 GDP deflator
➢ We saw how increases in nominal GDP can come either from an increase in real GDP, or
from an increase in prices. Put another way, if we see nominal GDP increase faster than
real GDP, the difference must come from an increase in prices.

➢ This remark motivates the definition of the GDP deflator. The GDP deflator in year t, Pt, is
defined as the ratio of nominal GDP to real GDP in year t: GDP Deflator: Average Price of Output
Output: Final Goods Produced

➢ Note that, in the year in which, by construction, real GDP is equal to nominal GDP this
definition implies that the price level is equal to 1 (or 100). This is worth emphasizing: The
GDP deflator is called an index number. Its level is chosen arbitrarily and has no economic
interpretation. Bur its But its rate of change, has a clear economic interpretation: It gives the
rate at which the general level of prices increases over time - the rate of inflation.
 Consumer price index (CPI)
CPI: Average price of consumption (Cost of Living)

➢ The GDP deflator gives the average price of output - the final goods produced in the economy. But consumers
care about the average price of consumption - the goods they consume. The two prices need not be the same.
The set of goods produced in the economy is not the same as the set of goods purchased by consumers, for
two reasons:

• Some of the goods in GDP are sold not to consumers but to firms (machine tools, for example), to the
government, or to foreigners

• Some of the goods bought by consumers are not produced domestically but are imported from abroad

➢ To measure the average price of consumption, or, equivalently, the cost of living, macroeconomists look at
another index, the Consumer Price Index, or CPI. For example in the in the United States CPI has been
computed since 1917 and is published monthly (in contrast, numbers for GDP and the GDP deflator are only
constructed and published quarterly). C P I : M o n t h l y
GDP &GDP deflator: quarterly
➢ The CPI gives the cost in dollars of a specific list of goods and services over time. The list, which is based on a
detailed study of consumer spending, attempts to represent the consumption basket of a typical urban consumer
and is updated every two years. Each month, Bureau of Labor Statistics (BLS) employees visit stores to find out
what has happened to the price of the goods on the list; prices are collected for 211 items in 38 cities. These
prices are then used to construct the CPI.
Price level vs inflation
 Why we care about inflation?
Inflation affects on Income Distribution (Retirees) . Uncertainty (Investment Options), Taxation (Distortion, Higher Tax Bracket, Increse Nominal Income but
Real Income Remains same )

➢ During periods of inflation, not all prices and wages rise proportionately. Because they
don’t, inflation affects income distribution. For example, retirees in some countries
receive payments that do not keep up with the price level, so they lose in relation to
other groups when inflation is high. At the same time, rising food proses affect more
poorer part of the population.

➢ Inflation leads to other distortions. Variations in relative prices also lead to more
uncertainty, making it harder for firms to make decisions about the future, such as
investment decisions. Some prices, which are fixed by law or by regulation, lag behind
the others, leading to changes in relative prices.

➢ Taxation interacts with inflation to create more distortions. If tax brackets are not
adjusted for inflation, for example, people move into higher and higher tax brackets as
their nominal income increases, even if their real income remains the same.
 Important remarks
➢ GDP Inflation & Unemployment data are released Limitations of GDP Data
on quarterly/monthly basis.
GDP usually does not include any black markets production
➢ Economic growth through rising GDP is seen as GDP as a whole does not indicate the standard of living
favourable when maintained at stable levels GDP also does not include other forms of unreported labour
GDP does not include environmental costs of economic output
➢ While minimal unemployment is a regular target for
central banks, desired levels of inflation may Limitations of Inflation Data
fluctuate depending on current economic policies–
typically however a target of 2% inflation is the Notably the primal limitation of the given data releases is the basket of
target norm goods used to produce the data. With substitute goods not being taken
into consideration in addition to the good basket being arguably debated
as outdated, other inflationary data may be needed to take into account
for more accurate interpretation

Limitations of Unemployment Data

There are numerous limitations that may arise whilst attempting to

interpret unemployment data (we listed them already). For instance the
given dataset does not take into account discouraged workers being
individuals who looked for jobs at some point in the past 12 months, but
not in the four weeks prior to the Bureau of Labour Statistics (BLS)
conducting their monthly household surveys
Thank you!