Macroeconomic Diagnostics (MDSx)

Module 3

Analyzing Aggregate Demand

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Course: MDSx
Module: 3
Section: 1

Video #: 1
Video Title: About Module 3
Video Type:
 Required to effectively communicate video segments.

Course: MDSx
Module: 3
Section: 2

Video #: 1
Video Title: Aggregate Demand and the Economy
Video Type: Standard
Aggregate Demand

Let us recall that …

… it is the total final demand of all goods and services in

an economy.

… it can shift in the short-run and cause fluctuations in

economic activity.
Aggregate Demand Curve Shift and Equilibrium

P AS

P2

P1
AD2
AD1

Y1 Y2 Real GDP
Aggregate Demand and the Business Cycle

In the short-run, shifts in aggregate demand affect the

level of output and inflation.

Recognizing the level of aggregate demand requires

analyzing its components.
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Course: MDSx
Module: 3
Section: 2

Video #: 2
Video Title: Components of Aggregate Demand
Video Type: Standard
Components of Aggregate Demand

AD ≡ C p + I p + G + NX
Aggregate Private Private Government Net
Demand Consumption Investment Expenditures Exports
Aggregate Demand

GDP Component Shares (% of Real GDP)

70

60

50

40

30

20

10

-10
Private Private Public Public Inventory Net Exports
Consumption Investment Consumption Investment
1998-2001 2002-2005 2006-2009 2010-2015
Aggregate Demand

The Economic Impact:

Consumption

Investment impacts on capital accumulation

Net exports

Government spending
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Course: MDSx
Module: 3
Section: 3

Video #: 1
Video Title: Growth Decomposition of Aggregate Demand
Video Type: Standard
Growth in Aggregate Demand

Computing what led to demand growth:

How much growth in each component

Proportion/weight of each component relative to total

aggregate demand
Contributions to Growth

Aggregate Demand analysis tells us…

… the component that is driving short-term growth.

 Household consumption

 Private investment

 Government spending

 External demand
Change in Components of Aggregate Demand

∆GDP ≡ ∆C p + ∆I p + ∆G + ∆NX
Contribution to Growth

∆𝐺𝐺𝐺𝐺𝐺𝐺 ∆(𝐶𝐶𝑝𝑝 + 𝐼𝐼𝑝𝑝 + 𝐺𝐺 + 𝑁𝑁𝑁𝑁)

=
𝐺𝐺𝐺𝐺𝐺𝐺 𝐺𝐺𝐺𝐺𝐺𝐺

∆𝐶𝐶𝑝𝑝 𝐶𝐶𝑝𝑝 ∆𝐼𝐼𝑝𝑝 𝐼𝐼𝑝𝑝 ∆𝐺𝐺 𝐺𝐺 ∆𝑁𝑁𝑁𝑁 𝑁𝑁𝑁𝑁

= × + × + × + ×
𝐶𝐶𝑝𝑝 𝐺𝐺𝐺𝐺𝐺𝐺 𝐼𝐼𝑝𝑝 𝐺𝐺𝐺𝐺𝐺𝐺 𝐺𝐺 𝐺𝐺𝐺𝐺𝐺𝐺 𝑁𝑁𝑁𝑁 𝐺𝐺𝐺𝐺𝐺𝐺
 Required to effectively communicate video segments.

Course: MDSx
Module: 3
Section: 3

Video #: 2
Video Title: Growth Decomposition in Excel
Video Type: Excel
 EXCEL
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Course: MDSx
Module: 3
Section: 3

Video #: 3
Video Title: Analysis and Interpretation of Contributions to Growth
Video Type: Standard
Demand Side Growth Decomposition

Past/Historical Perspective:
Identifies which sectors accounted for the growth

Provides insight into the weaknesses and strengths

Reveals vulnerabilities

Sustainability
Demand Side Growth Decomposition

Present Perspective:

Identifies the sector that is driving growth at present

Assists analysis of boom/recession/crisis

Demand Side Growth Decomposition

Future/Predictive Perspective:
Helps predict sector that may perform best

Tells us if it is sufficient to drive growth in demand

Identify sustainability of domestic and/or external demand

Contributions to GDP Growth

Contributions to Growth: Investment vs. Consumption

10

-2

-4

-6

-8

-10

-12
Q1-1999 Q1-2001 Q1-2003 Q1-2005 Q1-2007 Q1-2009 Q1-2011 Q1-2013 Q1-2015

Investment Consumption Real GDP Growth

Growth Decomposition

Within a recession/crisis:

Before Possible During

Recovery
Crisis Reasons Crisis

Unsustainable Too much Consumption Which sectors

growth in consumption, and investment account for
demand investment plummet. Net recovery
exports rise
Growth Decomposition Applied

In application to the case study country:

Calculate the contributions to growth from the demand side

Evaluate your findings using the different perspectives we

have discussed
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Course: MDSx
Module: 3
Section: 4

Video #: 1
Video Title: Analysis of Consumption
Video Type: Standard
Consumption

Some key aspects:

The largest component of aggregate demand

Fluctuations in household consumption can impact GDP

Recognize the determinants of consumption and its behavior

over the business cycle
Consumption

Durables Non-Durables Services

Are highly cyclical Not very cyclical Not very cyclical

Examples: Examples: Examples:

 Automobiles  Food  Haircuts
 Furniture  Clothing/Shoes  Transportation
 Household  Fuel
Appliances
Determinants of Consumption

Higher current income, leads to…

Current Income
… Higher current consumption and Higher saving

Expected Future Higher future income, leads to…

Income … Higher current consumption and Lower saving

Higher uncertainty about future income, leads to…

Uncertainty …Higher saving due to precautionary motive

Higher wealth, leads to…

Wealth … Higher current consumption, Lower saving

Higher interest rates typically leads to…

Interest Rate … Lower current consumption, Higher saving
Durables Consumption

≠
Spending on
Consumption of
consumer
durable goods
durables

Some notes:
Tends to be volatile
Often more pro-cyclical than other consumption spending
Consumption, Savings, and Disposable Income

The Household’s Budget Constraint:

Consumption
+ Savings
= Disposable
Income
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Course: MDSx
Module: 3
Section: 4

Video #: 2
Video Title: Determinants of Consumption in Excel
Video Type: Excel
 EXCEL
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 Required to effectively communicate video segments.

Course: MDSx
Module: 3
Section: 5

Video #: 1
Video Title: Analysis of Investment
Video Type: Standard
Components of Investment

Private Fixed Inventory Government

Investment Investment Investment

Firms’ capital Change from previous Public Capital

formation period
Examples:
Examples: Examples:
 Highways
 Nonresidential  Car inventories
 Ports
structures
 Unsold merchandise
 Firms’ machines and
equipment
Determinants of Private Investment

Some key aspects:

Includes spending by businesses and households on fixed
assets.

More volatile than consumption, and depends on…

 Rate of Return
 Expected future income
 Cost of finance
 Access to financing
 Uncertainty
Investment and the Capital Stock

Demand for capital, derived from the Production Function:

Technical Labor Capital
Progress Supply Stock

Y = f ( A, L, K )

K t =( K t −1 − δ K t −1 ) + It
Gross
Capital Stock Depreciation
Investment
Investment OECD Averages

Investment
(In percent of GDP, 2004–08 average)

Source: Asia and Pacific REO (April 2010, Ch. 3)

 Required to effectively communicate video segments.

Course: MDSx
Module: 3
Section: 5

Video #: 2
Video Title: Determinants of Investment in Excel
Video Type: Excel
 EXCEL
Place at the beginning and end of planned video segments.
 Required to effectively communicate video segments.

Course: MDSx
Module: 3
Section: 6

Video #: 1
Video Title: Aggregate Demand and the External Sector
Video Type: Standard
Aggregate Demand

GDP = C p + I p + Cg + I g + ( X − M )

G

GDP = C p + Cg + I p + I g + ( X − M )

  
C I
External Sector and Current Account Balance

Gross National Disposable Income add net factor income and net
transfers to GDP:

GNDI =GDP + Y f + TR f =C + I + ( X − M ) + Y f + TR f
 
CAB

=
GNDI − (C + I ) CAB =
GNDI − A CAB

A
 Required to effectively communicate video segments.

Course: MDSx
Module: 3
Section: 6

Video #: 2
Video Title: Aggregate Demand and Savings
Video Type: Standard
Savings

Key attributes:
Purpose is to increase resources for future consumption

Protect against an unexpected loss of household income

Allows financial assets to be channeled into productive

investments
Aggregate Demand Savings and Investment

Aggregate relationship:

GDP = C + I + NX
GDP + Y f + TR f =C + I + ( NX + Y f + TR f )
⇒ GNDI − C = I + CAB
⇒S−I = CAB

Aggregate Saving (Private and Public):

S − I= (S p − I p ) + ( S g − I g )= CAB
⇒ S p = I p − ( S g − I g ) + CAB
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Course: MDSx
Module: 3
Section: 7

Video #: 1
Video Title: Aggregate Demand and the Business Cycle
Video Type: Standard
The Business Cycle

Key features:
Defined as the repeated process of economic expansion,
decline/contraction, and recovery.

Temporary deviations from a ‘normal growth path’.

All are different in terms of length, deviation.

All have common features in their patterns.

Business Cycle

20
Private Consumption Public Consumption
Public Investment Private Investment
15 Change In Inventory Net Exports

10

-5

-10

-15

-20
Q1-1999 Q1-2001 Q1-2003 Q1-2005 Q1-2007 Q1-2009 Q1-2011 Q1-2013 Q1-2015
 Required to effectively communicate video segments.

Course: MDSx
Module: 3
Section: 7

Video #: 2
Video Title: Business Cycle and Co-movements
Video Type: Standard
Co-Movements and the Business Cycle

Direction:
Procyclical – Move the same direction
Countercyclical – Move the opposite direction
Acyclical – No clear movement

Timing:
Leading – Move in advance of aggregate economic activity
Coincident – Move at the same time
Lagging – Move later
Leading Economic Indicators

Variable Direction Timing

Production

Industrial Production Procyclical Coincident

Expenditure

Consumption Procyclical Coincident

Business Fixed Investment Procyclical Leading

Labor Market

Unemployment Countercyclical Not classified by NBER

Financial

Stock prices Procyclical Leading

High Frequency Indicators

Some attributes:
Economic indicators that co-move with GDP
Can be used to now-cast GDP based on a dynamic factor
model

Example – Federal Reserve System in US uses:

 Employment
 International Trade
 Retail and consumption
Assessing the State of the Economy

Familiarity with cyclical patterns of key macro variables:

Can help detect when the economy may be off track

Can help give insight to current quarter and year

Can help direct investigation and diagnosis

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Course: MDSx
Module: 3
Section: 8

Video #: 1
Video Title: Summarizing What We Learned
Video Type: Standard
Summarizing What We Learned

How to identify the components of aggregate demand.

How to compute contributions to growth of aggregate demand.

How to analyze main drivers of consumption and investment.

How to analyze aggregate demand over the business cycle.

 Required to effectively communicate video segments.

Course: MDSx
Module: 3
Section: 9

Video #: 1
Video Title: Assessing Diagnostica
Video Type: Standard