Saturday, October 10, 2009

Explaining Empirical Macro Trends With Theory

Having studied the detailed data over movements of components in the GDP of different EU countriess some observations can be made:

1) In all countries, investment spending was weaker than private consumption and GDP. If durable goods consumption had been included in investments, the relative weakness of investments would likely have been even greater.

2) In all countries except Poland, government consumption was stronger than GDP. And in all countries except Poland, Malta and Austria, government consumption was stronger than private consumption.

3) In all countries foreign trade activity dropped dramatically(especially if we exclude Ireland, whose trade statistics is distorted by internal corporate pricing encouraged for tax reasons).

4) All countries except Poland experienced a reduction in GDP.

Can these consistent or almost consistent empirical trends be explained by sound economic theory? Yes, it can.

Observation number one can be explained by the Austrian business cycle theory, which says that investment spending is more cyclical than consumption because it is more sensitive to interest rates and therefore to monetary policy.

Observation number two largely reflects that fact too, and also the fact that since governments can maintain consumption with borrowed money in the event of income shortfall, government consumption is likely to be even less cyclical than private consumption.

And observation number three reflects in part the fact that because the less cyclical sectors of services and non-durable goods are less tradable than durable goods, trade should fluctuate up and down than output. This causal relation in effect says that fluctuations in output will cause a bigger fluctuation in trade because of differences in sectoral composition between GDP and international trade In part it also reflects that with reduced trade, the benefits from comparative advantage will be reduced, reducing the real value of output. This causal relationship in effect says that reductions in trade flows both in and out will reduce real GDP even if the net export variable in the accounting standard used to determine GDP is unchanged, or in other words that the reduction in trade flows causes a reduction in output.

What about the Polish exception noted in observations number two and four? Well, as I noted here, this likely in part reflects that Poland's economy has a less cyclical sectoral composition than most other countries (and unlike many other countries it never had a housing bubble), and also the fact that the Polish government focused on reducing tax rates as a way to fight the crisis.


Post a Comment

<< Home