II. Measuring and Analyzing GDP

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A Macroeconomic Perspective on the A Macroeconomic Perspective on the

Real Sector: Growth, Economic Real Sector: Growth, Economic ,,

Fluctuations and Inflation Fluctuations and Inflation

Workshop for Staff of Workshop for Staff of

Ministry of National Planning and Economic Development Nay Pyi Taw, Myanmar

June 2 – 3, 2014, Jan Gottschalk

TAOLAM TAOLAM TAOLAM TAOLAM

IMF-TAOLAM training activities are supported by funding of the Government of Japan

Outline Outline

I. Real Sector Overview

II. Measuring and Analyzing GDP III. Sources of Growth

IV. Inflation

V. Forecasting GDP

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Real Sector Overview Real Sector Overview

3

Real Sector Overview Real Sector Overview

What is the real sector about?

At one level, it is about

• Level of production in the economy

the economy

This means it is also about

• Employment

• Investment

• Income

• Consumption

4

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Real Sector Overview Real Sector Overview

What is the real sector about?

At another level, it is about prices such as

• Consumer prices

• Input prices

• WagesWages

In a market economy, prices clear markets which in turn determines which in turn determines production levels. We cannot separate between the two

5

the two.

Real Sector Overview Real Sector Overview

How do we measure economic output?

• Should we just add up all the (gross) output produced by businesses and households in the economy?

• No, this would lead to double counting! Example: wheat used in production of bread

T id d bl ti d t bt t

• To avoid double counting, we need to subtract intermediate inputs:

gross output - intermediate consumption = value added

• Gross domestic product (GDP): sum of value added across all sectors in the economy

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Real Sector Overview Real Sector Overview

Why is GDP so important?

• Measure of output

• Approximation of welfare

• Many other variables are moving broadly proportional to GDP (e g revenues)

proportional to GDP (e.g., revenues)

 GDP ratios

 GDP forecast is basis for revenue forecasts etc.

• Macroeconomic management: keeping GDP roughly in line with its potential

7

Real Sector Overview Real Sector Overview

Key concepts: Consumption

We distinguish between

• Final household consumption e g food consumption—e.g., food, housing, transportation

• Final government consumption e g consumption—e.g., electricity, fuel, office supplies

• Intermediate consumption—

aforementioned inputs i t d ti

8

into production

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Real Sector Overview Real Sector Overview

Key concepts: Investment

Additions to the

i l k

capital stock, e.g., purchase of

machinery or machinery or construction of buildings g

9

Real Sector Overview Real Sector Overview

Key concepts: Exports

30

30 Food Gas

Main Exports

(In percent of GDP)

What

Myanmar

20

25 20

25

Food Gas

Garments Wood

Other Total Exports

y

sells abroad…

10 15 10

15

5 10 5

10

0 0

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Real Sector Overview Real Sector Overview

Key concepts: Imports

What you buy from abroad …

11

Real Sector Overview Real Sector Overview

Key concepts: Nominal versus Real

 Nominal GDP: measures the value of output of the economy at current prices y p

 Real GDP: measures the value of output of the economy changes in an economy’s physical economy -- changes in an economy s physical output -- using prices of a fixed base year

 Changes in nominal GDP over time reflect changes in both prices and physical output

12

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Real Sector Overview Real Sector Overview

Key concepts: Distinction between nominal versus real is useful for (1) measuring purchasing power:

real is useful for (1) measuring purchasing power:

Example: Nominal wages  20%

If inflation was 10%, Real buying power grew Real buying power grew

BUT BUT

If inflation was 30%,

13

Real buying power shrank

Real Sector Overview Real Sector Overview

Key concepts: Distinction between nominal versus real

f l f ( ) f d ff f

is useful for (2) accounting for different GDP factors:

Value (V) = Price (P) * Quantity (Q)

Nominal GDP (V) = GDP Deflator (P) * Real GDP (Q) Fundamental relation to be used over & over !

 Approximation: ∆%V ≈ ∆%P + ∆%Qpp

 Exact relationship:

(1+ ∆%V/100) =(1+∆%P/100)*(1+∆%Q/100) (1+ ∆%V/100) =(1+∆%P/100)*(1+∆%Q/100)

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Outline Outline

I. Real Sector Overview

II. Measuring and Analyzing GDP

III. Sources of Growth IV. Inflation

V. Forecasting GDP

15

Measuring and Analyzing GDP Measuring and Analyzing GDP

Goods and services^{(real flo}

Estimate of GDP

Production Approach

Money (financial flow) ( sectoral "value added")

"Goods Market" Expenditure Approach

( Y = C + I + X - M )

HOUSEHOLDS PRODUCERS

"Factors Market"

NON-RESIDENTS

Income Approach (Y = wages + OS+TSP)

Wages (financial flow)

16 OS=gross operating surpluses of

enterprises (including profits, rents, interests) Labor (real flow) TSP=taxes less subsidies

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Measuring and Analyzing GDP Measuring and Analyzing GDP

Production approach: GDP Shares

45%

50%

Myanmar: Composition of GDP (Constant 2006/07 Prices)

30%

35%

40%

Agriculture Mining and Energy

10%

15%

20%

25%

Industry &

construction Services and trade

0%

5%

10%

200 200 200 200 200 201 201

17

05/06 06/07 07/08 08/09 09/10 10/11 11/12

Measuring and Analyzing GDP Measuring and Analyzing GDP

Production approach: real GDP growth by sector

25%

Myanmar: GDP Growth (Constant 2006/07 Prices)

GDP (constant 2006/07

15%

20%

GDP (constant 2006/07 prices)

Agriculture Mining and Energy

10% Industry & construction

Services and trade

0%

5%

20 20 20 20 20 20 20

005/06 006/07 007/08 008/09 009/10 010/11 011/12

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Measuring and Analyzing GDP Measuring and Analyzing GDP

Production approach: growth contributions by sector

12%

14%

Myanmar: GDP Growth (Constant 2006/07 Prices)

8%

10% Services and trade

Industry & construction

4%

6%

Industry & construction

Mining and Energy

0%

2%

20 20 20 20 20 20 20

Agriculture

GDP (constant 2006/07 prices)

19

005/06 006/07 007/08 008/09 009/10 010/11 011/12

Measuring and Analyzing GDP Measuring and Analyzing GDP

Expenditure approach:

 Absorption (A) =

Final Consumption (C) + Investment (I) p ( ) ( )

 Net Exports (X-M) p ( )

X = Exports of goods and services M = Imports of goods and services

 GDP = A + X – M

D ti D d F i D d

20

Domestic Demand Foreign Demand

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Measuring and Analyzing GDP Measuring and Analyzing GDP

Fiscal Policies Real

Sector

^{G; T}

Policies Sector

Monetary financing

/ h Monetary financing

Interest rates/exchange rate

CA=S-I

Monetary Policies Balance of

Payments

RM=NFA+NDC

21

Outline Outline

I. Real Sector Overview

II. Measuring and Analyzing GDP III. Sources of Growth

IV. Inflation

V. Forecasting GDP

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Sources of Growth Sources of Growth

A simple metaphor for thinking about growth:

Economy as a

machine: Transforming inputs such as labor and capital into outputs such as and capital into outputs such as goods and services.

23

Sources of Growth Sources of Growth

‘Economy as machine’ metaphor suggests …

… for more growth we need more inputs!

h But many inputs such as land, labor or

education are difficult

growth in the short run to procure in the short run, so …

… growth in the short run depends really on

investment.

24

Is this really true?

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Sources of Growth Sources of Growth

Alternatively, we need to use our existing inputs more efficiently!

efficiently!

This is about …

• Technical innovation (especially in advanced countries), and …

• … adoption of best practices and existing technologies (especially

d in emerging and developing countries)

25

Sources of Growth Sources of Growth

Growth accounting—quantifying growth factors

Growth accounting is based on production function that typically includes the following growth factors:

G h f i l hi h i l l li k d i ’

• Growth rate of capital, which is closely linked to a nation’s investment rate

• Growth rate of ‘Raw’ labor, i.e., growth in labor forceGrowth rate of Raw labor, i.e., growth in labor force measured in the number of available workers

• Growth of human capital, i.e., growth in the quality of

i di id l k f li k d h li

individual workers, often linked to schooling

• Technical progress, i.e., increase in efficiency of using above input factors, often called growth rate of total factor

input factors, often called growth rate of total factor productivity (TFP)

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Sources of Growth Sources of Growth

Growth accounting—advanced economies

So what are typically the most important growth drivers?

For advanced economies, TFP growth is often key:

Source: See DeLong, Growth Accounting, http://j-bradford-delong.net/macro_online/growth_accounting.pdf, p. 6 27

Sources of Growth Sources of Growth

Growth accounting—transition economies

• Capital deepening was on average the was on average the single most important growth driver

• Closely followed by TFP growth

Source: See Iradian (2007), Rapid Growth in Transition Countries: Growth-Accounting Approach, p. 16 28

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Sources of Growth Sources of Growth

Growth Experience in Asia

l d ll l

• Capital deepening was especially important in Asia, resulting from very high investment (and savings) ratios

• Human capital accumulation was another key factor in EastHuman capital accumulation was another key factor in East Asia during 1966-90

Source: See Young (1994), Tyranny of Numbers, p. 3 29

Sources of Growth Sources of Growth

Recent IMF Research Recent IMF Research Results on Growth Factors

Factors

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Sources of Growth Sources of Growth

Investment is associated with higher growth …

2 R l I ( f GDP)

20

25 Real Investment (percent of GDP)

10 15

5 10

0

t [–4,0] t [1,5]* t [6,10]**

LICs ith strong gro th

31

LICs with strong growth LICs with weak growth

Sources of Growth Sources of Growth

… and FDI appears especially beneficial

N t F i Di t I t t Fl 4

Net Foreign Direct Investment Flows (percent of GDP)

2 3

0 1 0

t [–4,0]*** t [1,5]* t [6,10]**

LICs with strong growth

32

LICs with weak growth

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Sources of Growth Sources of Growth

Growth takeoffs are associated with openness:

R l E ( f GDP)

30 35

Real Exports (percent of GDP)

15 20 25

0 5 10 0

t [–4,0] t [1,5] t [6,10]**

LICs with strong growth

33

LICs with weak growth

Sources of Growth Sources of Growth

Reigning in high inflation promotes growth:

2 I fl i (1990 2011) 20

25 Inflation (1990-2011)

10 15

0 5

[ 4 0]*** [1 5] [6 10]**

t [–4,0]*** t [1,5] t [6,10]**

LICs with strong growth LICs with weak growthg

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Sources of Growth Sources of Growth

Quality of institutions and governance is another important growth factor

another important growth factor

35

Sources of Growth Sources of Growth

Source: See Kaufmann and Kray, Growth Without Governance, p. 40 36

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Sources of Growth Sources of Growth

Sources of Growth

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Sources of Growth Sources of Growth

What does this imply for Myanmar?

Myanmar’s growth performance in coming years should benefit from

• Ongoing transition to market economy

 efficiency gains

• Greater trade integration g

 efficiency gains, innovation

• Public sector reforms

 quality of institutions

• Boost to education and health spending

 human capital formation

40

p

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Outline Outline

I. Real Sector Overview

II. Measuring and Analyzing GDP III. Sources of Growth

IV. Inflation

V. Forecasting GDP

41

Inflation Inflation

What is inflation?

• Inflation is a sustained increase in the overall price level

– Increase in average prices of all goods and services vs. change in relative prices of individual goods and services

S i d i

– Sustained increase vs. one- time increase in the price level

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Inflation Inflation

Why do we care about inflation?

• Reasonably low inflation is equivalent to price stability

 key element of macroeconomic stability

 matters for growth

• High inflation has adverse impact especially on poor

• Many macroeconomic variables have a price component, Many macroeconomic variables have a price component, for example:

l l * fl

Nominal GDP = Real GDP * GDP Deflator

 Inflation helps understanding the price component

43

 Inflation helps understanding the price component

Inflation Inflation

Inflation determinants

Π

^(Price^Inflation)

44

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Inflation Inflation

Inflation determinants in Myanmar:

reserve money matters … y

45%

40%

Reserve Money & Headline CPI (Y-o-Y Change in %)

30%

35%

40%

25%

30%

35%

15%

20%

25%

10%

15%

20% CPI (headline,

2010=100) Reserve money (right axis)

0%

5%

10%

-5%

0%

5%

(right axis)

45

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14

Inflation Inflation

… and so do international commodity prices:

60%

80%

35%

40%

Myanmar: Commodity Prices & Headline CPI (Y-o-Y Change in %)

20%

40%

20%

25%

30% CPI (headline,

2010=100)

-20%

0%

% 10%

15%

20%

All Commodity Price Index, 2005

= 100, includes both Fuel and

-60%

-40%

-5%

0%

5%

Ja M S Ja M S Ja M S Ja M S Ja M S Ja M S Ja

both Fuel and Non-Fuel Price Indices

an-08 May-08 Sep-08 an-09 May-09 Sep-09 an-10 May-10 Sep-10 an-11 May-11 Sep-11 an-12 May-12 Sep-12 an-13 May-13 Sep-13 an-14

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Inflation Inflation

The role of the exchange rate becomes visible when we consider quarterly inflation rates:

q y

40%

12%

14%

Exchange Rate & Headline CPI (Q-o-Q Change in %)

10%

20%

30%

6%

8%

10%

12%

CPI (headline,

-10%

0%

10%

0%

2%

4% 2010=100)

Exchange rate (lead 2,

i ht i )

-30%

-20%

-6%

-4%

-2%

Ja J N A S F J D M O M A Ja J N

right axis)

47

an-08 un-08 Nov-08 Apr-09 Sep-09 Feb-10 ul-10 Dec-10 May-11 Oct-11 Mar-12 Aug-12 an-13 un-13 Nov-13

Outline Outline

I. Real Sector Overview

II. Measuring and Analyzing GDP III. Sources of Growth

IV. Inflation

V. Forecasting GDP

48

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Forecasting GDP Forecasting GDP

Why does forecasting GDP matter?

• GDP forecast is the starting point for many other forecasts, e.g., revenues or imports

• Similarly, GDP forecasts are necessary for projecting GDP ratios

for projecting GDP ratios

• GDP forecasts are central for macroeconomic management

49

Forecasting GDP Forecasting GDP

It’s difficult …

• It’s very rare that the forecast hits exactly the mark (if so it’s just luck!) mark (if so, it s just luck!)

• The forecast ‘number’ is important (e.g., for the budget), but …

• … the ‘story’ behind the forecast is often as

forecast is often as important

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Forecasting GDP Forecasting GDP

General procedure

• Start with analyzing the past

 what were key developments and how are they going to affect and how are they going to affect the present and future?

• What do we know about the present (nowcast)?

• Forecast is an extrapolation of past and present taking policy past and present, taking policy (changes) into account

51

Forecasting GDP Forecasting GDP

Remember distinction between nominal and real:

 Nominal GDP: measures the value of output of the economy at current prices y p

 Real GDP: measures the value of output of the economy changes in an economy’s physical economy -- changes in an economy s physical output -- using prices of a fixed base year

 GDP deflator: price component of GDP, computed as Nominal GDP/Real GDP

52

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Forecasting GDP Forecasting GDP

Typical forecasting approach:

 Start with forecasting real GDP

 Forecast inflation

 Forecast GDP deflator as function of inflation

f t

forecast

 Compute

Nominal GDP = Real GDP x GDP Deflator

53

Forecasting Real GDP Forecasting Real GDP

Various approaches for forecasting real GDP:

 Forecast

– Potential output and output gap Potential output and output gap – Supply-side approach:

• Production function

• Sectoral forecasts

– Demand-side approach: pp

forecast expenditures (C + I + X - M)

– Reconciliation of Supply & Demand

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Forecasting Real GDP Forecasting Real GDP

Potential output and output gap:

Positive output gap:p g p demand > supply

Negative output gap:

d d l

demand < supply

55

Forecasting Real GDP Forecasting Real GDP

Supply-side: production-function approach

 Q = f (K, L, A)

where K = Capital where K = Capital

L = Labor

A = Technology, Institutions

 In the long run increasing supply requires

 In the long run, increasing supply requires increasing A (through structural policies)

56

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Forecasting Real GDP Forecasting Real GDP

Supply-side: sectoral forecasts

Forecast production in each sector separately as they may have different determinants, then add up the individual forecasts to , p obtain the total:

1 , 1

1 ,

1 ,^  ^  ^ 

 agrt mant sert

t GDP

GDP w GDP w

GDP w

...

, , ,

, ,

1    



t ser ser

t man man

t agr g agr

t t

w GDP w GDP

w GDP GDP

57

Forecasting Real GDP Forecasting Real GDP

) is often fairly steady and not that difficult to forecast

Leaves private investment (I_P

) as a very difficult element to

Leaves private investment (I_P

) as a very difficult element to

forecast because this tends to be fairly volatile

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Forecasting GDP Forecasting GDP

Fiscal Policies Real

Sector

^{G; T}

Policies Sector

Monetary financing

/ h Monetary financing

Interest rates/exchange rate

CA=S-I

Monetary Policies Balance of

Payments

RM=NFA+NDC

59

Forecasting GDP Forecasting GDP

Forecasting tools

IMF Article IV IMF Article IV mission will arrive on arrive on Wednesday C

Compare your own forecasts to those of the IMF!

60

the IMF!

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Outlook Outlook

Next, we will explore in more detail …

• … the fiscal sector, which helps with analyzing public consumption and investment (C

_G

& I

_G

)

But first we will have But first we will have

61