Macroeconomic Models and Stylised Facts

Macroeconomic Models and Stylised Facts

Learning Objectives

  • LO1: Knowledge of the difference between actual and potential output.

    • Actual output refers to the real GDP that an economy produces at any given time. It is influenced by factors like employment levels, capital stock, and technological advancements. Potential output, on the other hand, is the maximum level of output an economy can produce when all resources are fully employed. Understanding this gap is crucial for assessing economic performance and inflationary pressures.

  • LO2: Understanding of pro-cyclical, counter-cyclical, and a-cyclical variables.

    • Pro-cyclical variables move in the same direction as the overall economy (e.g., GDP, investment). Counter-cyclical variables move in the opposite direction (e.g., unemployment). A-cyclical variables show no clear relationship to the business cycle (e.g., population growth).

  • LO3: Awareness of lagging, leading, exogenous, and endogenous variables.

    • Leading variables predict future economic activity (e.g., stock prices), while lagging variables reflect past performance (e.g., unemployment rate). Exogenous variables are determined outside the model (e.g., government spending), and endogenous variables are determined within the model (e.g., GDP).

  • LO4: Ability to identify static and dynamic models.

    • Static models represent the economy at a single point in time, without considering changes over time. Dynamic models, conversely, incorporate how the economy evolves, often through differential or difference equations.

  • LO5: Understanding of basic issues surrounding causality and timing.

    • Causality refers to the relationship where one variable influences another. Timing is crucial because changes in one variable may affect another with a certain time lag, which must be considered in economic analysis.

U.K. GDP

  • Figure showing U.K. GDP (chained volume measure, seasonally adjusted, local currency).

  • Observations:

    • Five discernible downturns, which mark recessionary periods or significant economic contractions. Identifying these downturns helps in understanding the cyclical nature of economic activity in the U.K.

U.K. GDP: Nominal vs. Real

  • Figure comparing nominal and real U.K. GDP.

  • Implicit Price Deflator: Ratio of nominal to real GDP. This deflator is a measure of the average price level for all goods and services in an economy and is used to adjust nominal GDP into real GDP.

  • Observation:

    • Three of five downturns not observable in nominal GDP, indicating that inflation can mask underlying economic contractions if only nominal GDP is considered.

U.K. Real GDP Per Capita

  • Figure showing U.K. real GDP per capita with an exponential trend line.

  • Observations:

    • Flattening of the series since 2008, reflecting slower economic growth following the global financial crisis.

    • Gap between the trend and the actual series, indicating that the U.K. economy has not returned to its pre-crisis growth trajectory.

U.K. Trend GDP ('Potential' GDP)

  • Graph illustrating the flattening of the UK trend GDP. This flattening suggests a decrease in the long-term growth potential of the U.K. economy, possibly due to structural changes or decreased productivity.

Growth Rates

  • Formula for the growth rate of output (g_{yt}):

    • g{yt} = \frac{Yt - Y{t-1}}{Y{t-1}} * 100

  • Annual Compound Growth Rate (AGR):

    • Yt = ((1 + gy)^x)Y_0

    • Where x is the number of periods.

  • Rearranging for g_y:

    • gy \approx (\frac{Yt}{Y_0})^{\frac{1}{x}} - 1

  • Approximation for small growth rates:

    • gy \approx \frac{ln(Yt) - ln(Y_0)}{x}

  • If x = 1:

    • gy \approx ln(\Delta Yt)

Cross-Country Comparisons

  • Comparison of real GDP per capita for the U.K., France, and Germany.

    • Using a log scale helps discern growth rates (slopes reflect annual growth rates). Log scale transformation allows for easier comparison of growth rates, as equal slopes indicate equal growth rates.

    • Minimal growth before the industrial revolution. Economic growth was very slow and inconsistent before the onset of industrialization.

    • Post-war economic miracle of Germany’s recovery. Germany experienced rapid economic growth following World War II, often attributed to factors like the Marshall Plan and economic reforms.

U.S. GDP Growth

  • Natural log of U.S. real GDP trends upward with variations.

  • Macroeconomists separate explaining the trend from explaining the variations.

    • Growth theory explains the trend, focusing on long-term factors such as technological progress and capital accumulation.

    • Business Cycle theory explains the variations, addressing short-term fluctuations influenced by factors like monetary and fiscal policy.

  • Reference to