Macroeconomics_01302019.ppt

Macroeconomics

What’s an economist?

“Mathematician, historian, statesman, philosopher, in some degree . . . as aloof and incorruptible as an artist, yet sometimes as near the earth as a politician.”

-John Maynard Keynes-

What’s Macroeconomics? • Study of the economy as a whole, including growth in incomes, changes in prices, and the rate of unemployment. • Macroeconomists attempt both to explain economic events and to devise policies to improve economic performance.

How bout Microeconomics? • Study of how firms and individuals make decisions and how these decisionmakers interact. • Because macroeconomic events arise from many microeconomic interactions, all macroeconomic models must be consistent with microeconomic foundations, even if those foundations are only implicit.

3 Main Macroeconomic Variables 1. Output (level & growth) 2. Unemployment Rate 3. Inflation Rate

Philippine Economy at a Glance 1. Output (level & growth)

Philippine Economy at a Glance 1. Output (level & growth)

Philippine Economy at a Glance 2. Unemployment Rate

Philippine Economy at a Glance 3. Inflation Rate

Philippine Economy at a Glance

Philippine Economy at a Glance

Philippine Economy at a Glance 3. Inflation Rate

How ‘s this related to Finance? • Macroeconomics & Finance are intertwined. The Great Recession was a good example. • Ways in which Macroeconomics can be used in investing: 1.Top-down investing 2.General valuation of the stock market

How ‘s this related to Finance? 1. Top-down investing -Investment approach that consists of analyzing the “big picture” (world or domestic economy), then moving down to the industry –level then down to company-specific level. -no hard & fast rule so long as analysis goes from big to small picture

How ‘s this related to Finance?

How ‘s this related to Finance? Example: Big picture: Low interest rates

Small picture: Bank stocks

How ‘s this related to Finance? 2. Valuation a. Total Market Cap to GDP Ratio (Buffett indicator) b. Cyclically Adjusted Price to Earnings Ratio (CAPE, Shiller P/E, and P/E10 ratio)

How ‘s this related to Finance? 2. Valuation a. Total Market Cap to GDP Ratio (Buffett indicator) -A ratio used to determine whether an overall market is undervalued or overvalued.

How ‘s this related to Finance? “The market value of all publicly traded securities as a percentage of the country's business -- that is, as a percentage of GNP. The ratio has certain limitations in telling you what you need to know. Still, it is probably the best single measure of where valuations stand at any given moment.”

-Warren Buffett, Fortune Magazine 1999 & 2001-

How ‘s this related to Finance?

“If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200% -- as it did in 1999 and a part of 2000 -you are playing with fire.”

-Warren Buffett, Fortune Magazine 1999 & 2001-

How ‘s this related to Finance?

How ‘s this related to Finance?

How ‘s this related to Finance?

How ‘s this related to Finance?

How ‘s this related to Finance?

How ‘s this related to Finance? 2. Valuation b. Cyclically Adjusted Price to Earnings Ratio (CAPE, Shiller P/E, and P/E10 ratio) -A valuation measure, generally applied to broad equity indices, that uses real per-share earnings over a 10-year period

How ‘s this related to Finance? 2. Valuation b. Cyclically Adjusted Price to Earnings Ratio (CAPE, Shiller P/E, and P/E10 ratio) -a better market valuation indicator than the P/E ratio as it eliminates fluctuation of the ratio caused by variation of profit margins during business cycles

How ‘s this related to Finance? Computation steps: 1. Take the annual Earnings Per Share (EPS) of an index for the past 10 years 2. Express these earnings in today’s money (dollars) 3. Get the average of these real EPS for the 10 year period 4. Divide the current level of the index by the 10 year average 5. Compare the figure to its historical mean

How ‘s this related to Finance? 2018 index level: 1,131 2017 CPI: 227.20 2016 CPI: 218.70

Average real EPS:69.4 CAPE ratio: 16.3x Historical average of CAPE: 19x

Where does the US Market stand?

Historical Mean: 85% Current: 133.7%

Where does the US Market stand?

Historical Mean: 16.9x

John Maynard Keynes • Widely regarded as the father of Macroeconomics • Was a successful stock market investor in the later part of his investing career and held a concentrated portfolio instead of a diversified one. • Had Friedrich Hayek as his rival

John Maynard Keynes • The core of Macroeconomics evolved from the principles laid out in his 1936 book General Theory of Employment, Interest, and Money

John Maynard Keynes • His economic theories were the staple of the economic policies of developed nations in the later part of the Great Depression, World War II, and post War economic expansion.

• Went out of fashion during the stagflation of the 70’s • Saw a resurgence during the Great Recession

Friedrich Hayek -Austrian economist whose anti-biggovernment book, Road to Serfdom (1944), inspired Milton Friedman and many other libertarians -his 1945 article, “The Use of Knowledge in Society,” helped inspire the efficient market hypothesis

Aggregate Output Different Measures of Output:

1. Gross National Product (GNP) 2. Gross National Income (GNI) 3. Gross Domestic Product (GDP)

Aggregate Output Gross National Product (GNP)

-the market value of the goods and services produced by labor and property supplied by the residents of a particular economy (usually a state)

Aggregate Output Gross National Income (GNI) -based on a similar principle to GNP - sum of value added by all resident producers plus any product taxes (less subsidies) not included in the valuation of output plus net receipts of primary income (compensation of employees and property income) from abroad (World Bank)

Aggregate Output Gross National Income (GNI) -sum of value added by all producers who are residents in an economy, plus any product taxes (minus subsidies) not included in output, plus income received from abroad such as employee compensation and property income (Investopedia)

Aggregate Output Gross National Income (GNI) -the World Bank now uses GNI instead of GNP -The Philippine Statistics Authority (PSA) emphasizes GNI rather than GNP

Aggregate Output Gross Domestic Product (GDP)

-the market value of the goods and services produced by labor and property located in a particular economy (usually a state)

Aggregate Output Gross Domestic Product (GDP) 1. Value of the final goods & services produced in the economy during a given period (Production side)

2. Sum of value added in the economy during a given period (Production side) 3. Sum of Incomes in the economy during a given period (Income side)

Circular Flow-2 Sector Model

Circular Flow-2 Sector Model The inner loop represents the flows of labor and bread: households sell their labor to firms, and the firms sell the bread they produce to households The outer loop represents the corresponding flows of dollars: households pay the firms for the bread, and the firms pay wages and profit to the households

Circular Flow-4 Sector Model

Circular Flow-4 Sector Model Households receive income from firms & the government; purchase goods and services from firms; and pay taxes to the government They also purchase foreign-made goods and services (imports)

Circular Flow-4 Sector Model Firms receive payments from households and the government for goods and services; pay wages, dividends, interest, and rents to households; and pay taxes to the government

For exporters, they also receive payments for domestically-made good (exports) Sometimes, the firms also purchase imports

Circular Flow-4 Sector Model The government receives taxes from firms and households; pays firms and households for goods and services (including wages to government workers); and pays interest and transfers to households Sometimes, the government also purchases imports

Circular Flow-4 Sector Model Finally, people in other countries purchase goods and services produced domestically (exports).

Aggregate Output In this economy, GDP is both the total expenditure on bread and the total income from the production of bread

Because every transaction has a buyer and a seller, every dollar of expenditure by a buyer must become a dollar of income to a seller

Aggregate Output When Joe paints Jane’s house for $1,000, that $1,000 is income to Joe and expenditure by Jane The transaction contributes $1,000 to GDP, regardless of whether we are adding up all income or all expenditure

Aggregate Output Gross Domestic Product (GDP) Consider an economy composed of just 2 firms: Firm 1 produces steel, employing workers & using machines to produce the steel. It sells the steel for $100 to Firm 2, which produces cars. Firm 1 then pays its workers $80, leaving $20 in profit to the firm.

Aggregate Output Gross Domestic Product (GDP) Firm 2 buys the steel & uses it, together with the workers & machines, to produce cars. Revenues from car sales are $210. Of the $210, $100 goes to pay for the steel & $70 goes to workers in the firm, leaving $40 in profit to the firm. Compute the GDP.

Aggregate Output

Aggregate Output Value of the final goods & services produced in the economy during a given period (Production side)

GDP = $210 -Keyword here is final goods & services -Steel is an intermediate good, NOT FINAL!

Aggregate Output Sum of value added in the economy during a given period (Production side) GDP = $210 Value added = Production – value of intermediate goods

Aggregate Output

Aggregate Output Sum of Incomes in the economy during a given period (Income side) GDP = $210 Income= indirect taxes + labor income + capital income

Aggregate Output

Aggregate Output GDP = $210

Production side = Income side The figure should be the same whichever way one looks at it

Aggregate Output Computation caveats

1. Sale of used goods is excluded (only production in the current period is counted) 2. Increase in inventory is included (called inventory investment & counted as expenditure by owners) 3. Sale out of inventory has no effect on GDP 4. Underground economy is excluded

Aggregate Output Given the exclusion of the underground economy, GDP is an imperfect measure of economic activity

These imperfections are most problematic when comparing standards of living across countries

Aggregate Output The size of the underground economy varies widely from country to country Yet as long as the magnitude of these imperfections remains fairly constant over time, GDP is useful for comparing economic activity from year to year

Aggregate Output Types:

1. Nominal GDP/ GDP at current prices/ PHP GDP/ EUR GDP 2. Real GDP/ GDP at constant prices/GDP adjusted for inflation

Aggregate Output 1. Nominal GDP -sum of the quantities of final goods produced times their current price -definition makes clear that nominal GDP increases over time for 2 reasons: 1. Production of most goods increases over time 2. Prices of most goods also increase over time

Aggregate Output 1. Nominal GDP

-GDP computed this way is not a good gauge of economic well-being because this does not accurately reflect how well the economy can satisfy the demands of households, firms, and the government.

Aggregate Output 1. Nominal GDP

-If all prices doubled without any change in quantities, nominal GDP would double. Yet it would be misleading to say that the economy’s ability to satisfy demands has doubled, because the quantity of every good produced remains the same