Macroeconomic Issuesfor Strategic Managers Strategic Analysis and the Competitive Environment Dr. D. M. Gropper
Nobel Prize winning Economiston 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 • General Conditions • Unemployment rates • Inflation rates • International Issues • Exchange rates • Product prices: foreign vs. domestic • Government Policy
Macroeconomic Issues • Business Cycles: Output (GDP) Cycles • Expansion • Recession • Indicators of Cyclical Conditions • National Output - GDP • Unemployment Rate • Inflation Rate-CPI, PPI, GDP deflator
Macroeconomic Issues • Why do Business Cycles Occur • Private Sector reasons • Public Sector reasons • What to do about these fluctuations • Laissez-Faire • Activist Policy • Fiscal Policy • Monetary Policy
Macroeconomic Policy IssuesManaging the Business Cycle • Philosophical Issue - Should We? • Theoretical Issues - Can We? • Is 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
Macroeconomic Data, page 1 • Daily data sources • stock market • Bond and credit markets • Foreign exchange markets • Commodities markets
Macroeconomic Data, page 2 • Weekly releases • Federal Reserve - Money Supply and Credit Aggregates • Labor Department - New claims for unemployment insurance-”Jobless claims”
Macroeconomic Data, page 3 • Monthly and Quarterly Data • Real GDP - Quarterly releases, plus revisions • Components - monthly • Retail Sales • Disposable and overall personal income • Personal saving • Merchandise Trade
Macroeconomic Data, page 4 • Monthly and Quarterly Data Continued • Labor Market - Household survey, establishment survey • Industrial Production - Capacity utilization • Inflation • Consumer Price Index - monthly • Producer Price Index - monthly • GDP deflator - quarterly
Macroeconomic Data, page 5 • Index of Leading Economic Indicators- monthly by the Conference Board • 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 • government • societal • Mancur Olson “Rise and Fall of Nations..”
A Brief U.S. Monetary History • 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 !
The Federal Reserve System • 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 • 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 • 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” • 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
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) • 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 slope - lower expected future interest rates
Risk Structure of Interest Rates • 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: 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
Source: “Economic Freedom and Happiness”Gropper, Lawson and Thorne, Cato Journal, 2011