MGRECON 301 Global Economic Environment of the Firm

MGRECON 301 Global Economic Environment of the Firm Professor John Coleman Duke University Fuqua School of Business October 2009 Rethinking the Boundaries of Business School

Course Motivation • Why are some countries poor and others rich? • Why do countries undergo financial crises? • Why should a business manager understand his/her global economic environment?

Sustained Growth and Country-Level Income Inequality is a Modern Phenomenon World-Wide Per-Capita GDP

Most of the World is Poor

The 21 st Century may be the Century of Convergence 2007 population • 6. 7 billion - World • 1. 3 billion - China • 1. 1 billion - India China and India represent 36 percent of the world’s population

Many Poor Countries are Still Being Left Behind

Financial Crises in the 90’s Mexico Thailand Russia Argentina

U. S. Financial Crisis in 2008 Dow Jones Industrial Average The Treasury secretary, Henry M. Paulson Jr. , and the Federal Reserve chairman, Ben S. Bernanke, testifying on Capitol Hill regarding the $700 billion bailout of financial firms. Year The U. S. financial crises has spread around the world: contagion.

Macroeconomics and the Firm Financial Crises

Corporate Profits are Very Pro-Cyclical

U. S. Real GDP Note the Great Moderation beginning in the mid 1980 s.

Oil Price Nominal Real

Outsourcing and Wages Around the World

U. S. Current Account

Monetary Policy

Monetary Policy The Federal Funds Rate and the Taylor Rule

Monetary Policy During the 2008/09 Financial Crises

Inflation around the World Developed Countries: Inflation(year-over-year) (1/01/1990 - 09/24/2008) Frequency: Quarterly Magnitude: Percent Source: Cleveland Federal Reserve Bank World: Inflation(year-over-year) (1/01/1990 - 09/24/2008) Frequency: Quarterly Magnitude: Percent

Exchange Rates Yen has moved from 350 to about 100, why?

The Yield Spread and Economic Growth The slope of the yield curve predicts recessions (5 -year Treasury bond - 3 -month Treasury bill) Annual GDP Growth or Yield Curve % Real annual GDP growth 9 7 5 3 1 -1 20 03 20 01 19 99 19 97 Yield curve accurate in recent forecast 19 95 19 93 19 91 19 87 19 85 19 83 19 81 19 89 Recession Correct 2 Recessions Correct 19 79 19 77 19 75 19 69 -7 19 73 -5 Recession Correct 19 71 -3 Yield spread

U. S. Treasury Yield Curve October 13, 2009

National Income and Product Accounts (NIPA) Accounting system by which we organize our thinking to measure economic activity for a country.

Gross Domestic Product (GDP) • Market value of final goods and services newly produced within a nation during a fixed period of time – Market value – Newly produced final goods and services • Per capita GDP is an economy’s GDP divided by its population

The Income Expenditure Identity Y=C+I+G+NX – Y=GDP (Income) – C=consumption – I=investment – G=government purchases – NX=net exports • What is produced is spent somewhere.

The Income Expenditure Identity Expenditures in 1996 Billions of dollars Percent of GDP Personal Consumption Expenditures (C) 5151 68. 0 Gross private domestic investment (I) 1117 14. 7 Government purchases of goods and services (G) 1406 18. 6 Net exports (NX) -99 -1. 3 Exports 855 11. 3 Imports 954 12. 6 Total (equals GDP) (Y) 7576 100. 0

GDP is same as National Income GDP = National Income + Indirect taxes +Depreciation - NFP • The income approach says that what is produced is income to someone

National Income in 1996 Compensation of employees Proprietors' income Rental income of persons Corporate profits Net interest Total (equals National Income) Billions of dollars 4449 518 127 654 403 6151 Percent of GDP 58. 7 6. 8 1. 7 8. 6 5. 3 81. 2

National Saving S=Y+NFP-(C+G)

Current Account • This implies S=(C+I+G+NX)+NFP- C - G S=I+(NX+NFP) • CA = current account balance S=I+CA • CA=0 if closed economy (Cuba)

Budget Deficit Sg = (T-TR-INT)-G • • • T = Tax Receipts TR = Transfers to private sector INT = interest on national debt G = Government purchases Sg=Budget surplus if positive. If negative, then a budget deficit

Some Fundamental Prices

The General Price Level Y = nominal GDP Y=P*y • P = GDP deflator or simply market price • y = real GDP or quantity of goods produced

The General Price Level • Price growth = inflation: • Real GDP growth:

Consumer Price Inflation

Interest Rates • The (short-term) interest rate is the risk-free rate of return that can be earned in the market. • R ≡ Dollar interest rate • Invest $1 today at the rate R • Receive $(1+R) in one year. How much would you pay to receive $1 in one year?

Real and Nominal Interest Rates • The real interest rate, r, is the rate of return in units of goods. r = R - • (Ex post) real interest rate is nominal interest rate minus inflation.

Expected Inflation and Interest Rates • The inflation rate is typically not known • Expected (ex ante) real interest rate = nominal interest rate - expected inflation re = R - e • The expected real interest rate is the nominal interest rate less expected inflation – the Fisher equation

Inflation and Nominal Interest Rate in the United States R Nominal Interest Rate Inflation

Bond Price and Interest Rate • How much would you pay to receive $1 in one year? • If you paid Q, then your return would be (1 -Q)/Q • The return on the bond and the interest rate must be the same: Q = 1/(1+R) • Bond prices and interest rates move in opposite directions

Glossary of Terms GDP NFP GNP C I G X M NX S T TR INT Pt R r Gross Domestic Product (also Y) Net Factor Payments Gross National Product = GDP + NFP National Consumption National Investment Government Expenditure Exports Imports Net exports = X - M National Saving = Spvt + Sgovt Total taxes Transfer payments Interest payments Inflation General price level at time t Nominal interest rate Real interest rate