Transcript Macroeconomic issues

Macroeconomic Issues
for Strategic Managers
Strategic Analysis and the
Competitive Environment
Dr. D. M. Gropper
Nobel Prize winning Economist
on Inflation
“Inflation is everywhere and always a
monetary phenomenon.”
Milton Friedman
Popular baseball player and
“everyman philosopher” on inflation
“A dime ain’t worth a nickel anymore.”
Yogi Berra
Managers and Macroeconomic Issues
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General Conditions
Unemployment rates
Inflation rates
International Issues
 Exchange
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rates
Product prices: foreign vs. domestic
Government Policy
Macroeconomic Issues
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Business Cycles: Output (GDP) Cycles
 Expansion
 Recession
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Indicators of Cyclical Conditions
National Output - GDP
 Unemployment Rate
 Inflation Rate-CPI, PPI, GDP deflator
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Macroeconomic Issues
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Why do Business Cycles Occur
 Private
Sector reasons
 Public Sector reasons
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What to do about these fluctuations
 Laissez-Faire
 Activist
 Fiscal
Policy
Policy
 Monetary Policy
Macroeconomic Policy Issues
Managing the Business Cycle
Philosophical Issue - Should We?
 Theoretical Issues - Can We?
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 Is
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it even possible, in theory or reality?
Practical Issues and Experience Realistic Expectations
Macroeconomic management problems
Time and information problems
- lags in gathering information
- lags in making decisions
- lags in implementation
- lags in impact
 Targeting problems - leakage rates
 Secondary effects
 Good politics vs. good economics
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Macroeconomic Data, page 1
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Daily data sources
 stock
market
 Bond and credit markets
 Foreign exchange markets
 Commodities markets
Macroeconomic Data, page 2
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Weekly releases
 Federal
Reserve - Money Supply and
Credit Aggregates
 Labor Department - New claims for
unemployment insurance-”Jobless claims”
Macroeconomic Data, page 3
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Monthly and Quarterly Data
 Real
GDP - Quarterly releases, plus revisions
 Components - monthly
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Retail Sales
Disposable and overall personal income
Personal saving
Merchandise Trade
Macroeconomic Data, page 4
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Monthly and Quarterly Data Continued
 Labor
Market - Household survey,
establishment survey
 Industrial Production - Capacity utilization
 Inflation
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Consumer Price Index - monthly
Producer Price Index - monthly
GDP deflator - quarterly
Macroeconomic Data, page 5
Index
of Leading Economic Indicatorsmonthly by the Conference Board
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Components
• Avg weekly hours of production workers, mfg.
• Avg weekly initial claims for unemployment
• Manufacturer’s new orders for consumer
goods and materials (In constant $s)
• ISM Index of new orders
Macroeconomic Data, page 5
 Index
of Leading Economic Indicators cont.
• New contracts and orders for plant and
equipment (non-defense)
• Building permits for new private housing
• Stock Prices (S&P 500)
• Leading credit index (Conf.Bd. TM)
• Interest rate spread, (10-yr treasury bonds
minus fed funds rate)
• Index of Consumer sentiment - Survey by U
of Michigan
 C.B. also does Global Business Cycle Indicators
Macroeconomic Data, page 6
 Accuracy
…..
 Revisions …..
Determinants of Economic Growth Rates
Technology
 Resources
 Infrastructure
 Institutions
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 government
 societal
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Mancur Olson “Rise and Fall of
Nations..”
A Brief U.S. Monetary History
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early years - mixed currencies
1800’s: Private bank notes circulating
1913: Formation of the Federal Reserve system
Replace private bank notes with FR notes
Reduce, then drop Gold and Silver backing for
FR notes
Overall trend and lessons for today?
Monetary Principles
Full bodied vs. token money
 Debasement controversy -- debasement
is theft !
 Gresham’s Law -- Bad money drives out
the Good !
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The Federal Reserve System
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Structure: Board of Governors, FOMC, etc.
Philosophy: Independence! (& obfuscation)
Goals: sustainable GDP growth, low
unemployment, low interest rates, low
inflation
Policy Tools: Discount rate, Open Market
Operations, Reserve requirements
Federal Reserve System, page 2
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Operations during early 1970s - efforts to hit
and maintain lower interest rate targets led to
increased inflation.
Volcker shift in October 1979 - switch from
targeting FFR to targeting reserves (and the
money supply)
Why announce?
Short run vs. long run effects --- on the
economy, and on Carter and Reagan…..
Federal Reserve System, page 3
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Operations during 1980s and 1990s - efforts to hit
monetary targets often missed, but interest and
inflation still reasonable…...
Deregulation and innovation in financial markets
changes things….which money supply to target?
Late 1990s through 2000s….whither Greenspan and
the Fed???
In 2006 – Ben Bernanke succeeds Greenspan
Financial crisis - 2008 …housing, subprime lending
problems, bank credit & real economy, Euro area, etc
Challenges in 2012 – what should the Fed do?
…..what CAN the Fed do?
Fed “Watching”
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What to watch? Desiderata: controllable,
important, regularly/frequently available
Possible items:
 Aggregates:
total or nonborrowed reserves,
monetary base, money supply
 Interest rates: short term (FFR), medium and
longer term: prime rate, 30yr bond rate
 Speeches, etc.
Budget Deficits, Surpluses and
the National Debt
Sheer size -- millions, billions, trillions.
 Temptation to finance by inflation
 Refinance to short term interest rates
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Term Structure of Interest Rates
(yield curve analysis)
 Two
elements of yield on long
term bond:
1. average of expected yields on
short term bonds over same time
period
2. add a risk premium for longer
bond
Term Structure of Interest Rates
(yield curve analysis)
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Yield curve interpretation:
 steep
upward slope - higher expected future interest
rates (and higher expected inflation rates)
 shallow
upward slope - expected future interest
rates same, slope reflects risk premium only
 downward
rates
slope - lower expected future interest
Risk Structure of Interest Rates
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Spread between bonds of differing default
risk, U.S. Treasury vs. Corporate bonds
increasing spread gives early indication of
recessions
decreasing spread gives early indication of
expansions
Useful as a market indicator of expected
business conditions
Federal Reserve Interest Rate policy:
1999 through mid-year 2001
Federal Reserve Interest Rate policy:
2000 through early 2002
Federal Reserve Interest Rate policy:
2002 through mid-year 2004
Federal Reserve Interest Rate policy:
2002 through mid - 2005
Federal Reserve Interest Rate policy:
2004 through mid - 2007
Federal Reserve Interest Rate
policy: 2006 through mid – 2009
Federal Reserve Interest Rate
policy: 2008 through mid – 2012
(as printed in July 2012 report)
International Central Bank Interest Rate policy:
2005 through early - 2012
• after the creation of the single currency system, many believed that
a single currency also meant the risk of sovereign debt was the same
across counties. The financial crisis revealed that the political and
institutional difference between countries yielded widely differing
performance.
Euro Adoption and EU Interest Rates
• So what did the shift to the Euro do? Essentially it acted as an internal price
control allowing internal interest rates to fall in countries where previous
expectations of inflation kept those rates high (Greece, Italy, etc). Governments in
those countries increased their borrowing to finance growing budget deficits that
came with larger social transfer programs.
• The result was rapidly rising ratios of public debt to GDP in the PIIGS (Portugal,
Italy, Ireland, Greece and Spain). As the graph shows, the bond market at the
time viewed all bonds issued by Euro countries to be equally safe. Global capital
markets did not require higher interest rates on countries with rapidly increasing
debt to GDP ratios despite the increased risk associated with this pattern of fiscal
performance. In short, the markets were sorting out the “no bailout” provision of
the Maastricht treaty. The minimal divergence between the interest rates on
Greek and German government bonds before the crisis reflected the belief that at
the end of the day, the EU would cave in on the “no bailout” clause. Germany and
France were expected to come to the rescue. But will they? We are in the middle
of this discussion in January, 2012.
Fiscal Policy Lessons learned
Tax rate changes have largest
effects when viewed as permanent
“Deadweight loss” from tax
increases can be considerable
Expansionary effects of deficit
spending are not likely to be large
Tax rebates are not as stimulative
as tax rate cuts of similar dollar
amounts
Monetary Policy Lessons learned
 Central bank credibility is key
 Regulations matter, sometimes a lot
 Money and Interest rate changes are more rapidly
enacted than tax changes, but affect things with a
long lag
 Monetary policy changes have largest effects
when unanticipated
 “Deadweight loss” from unanticipated inflation can
be considerable
 Transmission mechanism can be soft
 Internationalization has fully arrived
Economic Freedom and Happiness
230
210
Happiness 190
170
150
Quartile 1
Less
Freedom
Quartile 2
Quartile 3
Quartile 4
More Freedom
Economic Freedom
Source: “Economic Freedom and Happiness”
Gropper, Lawson and Thorne, Cato Journal, 2011
So, where are we now, and where are we going?