73-240 Fall 2015

73-240 Problem set 1, Answer Key

Due Friday Sep. 11th

Problem 1: Getting Started, Using Logarithms (5 pts)

When calculating GDP growth rates, economists like to use the dierence in the natural
logarithm of GDP as an approximation for an economys growth. In this question, we will
examine the usefulness of describing economic variables in terms of its natural log.
Some background info: As a review, lets recall what happens with compound interest
rates. Suppose you invest X1 for one year at interest rate r = 2%. At the end of the year, you
get X2 = (1 + r)X1 , i.e. X2 = (1.02)X1 . Interest can be compounded, sometimes, you might
get a return every quarter. Suppose the annual interest rate is still r = 2, then compounded
quarterly, your final return at the end of the year is X2 = (1 + 4r )4 X1 or X2 1.0202. As
the frequency of compounding gets large, the formula (1 + rt )t converges to :
r
lim (1 + )t = er
t!1
t
This means if your money gets compounded continuously, at the end of the year you would
have X2 = er X1 .
Now we can see that to recover the interest rate or growth rate of your investment, we can
do a very simple transformation of the above equation by taking the natural logarithm on
both sides
X2
ln
= ln X2 ln X1 = r
X1
We can now do a very simple subtraction of two log variables to get out the growth rate!
QUESTION 1
a Download data on Annual Real GDP for the US economy from FRED (see instructions
below) for the period covering 1976-2014. Calculate the growth rate of Annual Real
t GDPt 1
GDP for each year by using the formula: gt = GDPGDP
. Find the average growth
t 1
g1977 +g1978 ++g2014
rate across all years, i.e. calculate gavg =
2014 1977
Answer
See attached spreadsheet (last page) for answers.
gavg = 0.0277 or 2.77%.
b Now calculate the annual growth rate for each year as: gt = ln(GDPt ) ln(GDPt 1 ).
Again find the average growth rate, gavg , across all years. Is there a large discrepancy
This version: September 11, 2015

Prof. Shu Lin Wee

73-240 Fall 2015

between your answer in part (a) and part (b)? Plot the two calculated growth rate
series, gt and g.
Answer
See attached spreadsheet (last page) for answers.
gavg = 0.0272 or 2.71%.
c Calculate the correlation between the growth rate gt and gt you found in part (a) and
part (b)
Correlation = 0.999888 1
Final notes on logarithms: One more useful aspect about using logs is in terms of making
comparisons. Suppose GDPt = 100. Saying that GDP rose by 50% in period t + 1 but then
fell by 50% in t + 2 does not give us back 100 in period t + 2. However, if we said that GDP
rose 50 log points in t + 1 and dropped 50 log points in t + 2, we would be back at the same
level of GDP in period t + 2 as in period t.

Problem 2: Recessions and Recoveries (5 pts)

This question requires you to think about what kind of growth rate you would need for the
economy to return back to its trend path.
Argue whether the following is true or false. An aspiring student argues that something
that aects the growth rate of a variable for only one period has an impact that only lasts
one period.
a Using the same data as in question 1, calculate the average growth rate of the US
economy for the period 1976-2007. The average growth rate is calculated as: gavg =
g1977 +g1978 ++g2007
.
2007 1977+1
Answer
t GDP t 1
If using the formula gt = GDPGDP
, then gavg = 0.0317 or 3.17%.
t 1
If using the formula gt = ln(GDPt ) ln(GDPt 1 ), then gavg = 0.0311 or 3.11%.
b Using your answer from part (a) and the value of annual real GDP in 2007, calculate
how much GDP would be in 2010 if the US economy grew at the constant growth rate,
gavg , and if the Great Recession never happened.
[Hint: Recall to calculate GDP one period ahead, we can use the formula GDPt+1 =

This version: September 11, 2015

Prof. Shu Lin Wee

73-240 Fall 2015

(1 + g)GDPt . Alternatively, if using natural logs, then ln GDPt+1 = g + ln GDPt ]
Answer
t GDP t 1
If using the formula gt = GDPGDP
, then GDP2010 16334
t 1
If using the formula gt = ln(GDPt ) ln(GDPt 1 ), then ln(GDP2010 ) 9.7.
c The US economy went into a recession at the end of 2007 and exited the Great Recession in June 2009. Using the value of annual real GDP in 2009, calculate the level
of GDP in 2010 if the economy reverted back to the average growth rate calculated in
part (a).
Answer
GDP2010 14876
ln GDP2010 9.6
d Is your answer in (c) the same as your answer in (b)? What does this imply about the
growth rate we would want to see in a recovery for an economy to return back to its
trend path? Calculate the growth rate required in 2010 for the economy to achieve the
level of GDP in 2010 as recorded in part (b).
Answer
We would need to see a higher than trend growth rate for the economy to return back
to the predicted 2010 level as calculated in part (b).
t GDP t 1
If using the formula gt = GDPGDP
, g 0.13
t 1
If using the formula gt = ln(GDPt ) ln(GDPt 1 ), then g 0.12

This version: September 11, 2015

Prof. Shu Lin Wee

Frequency: Annual
observation_date
GDPCA
1976-01-01
1977-01-01
1978-01-01
1979-01-01
1980-01-01
1981-01-01
1982-01-01
1983-01-01
1984-01-01
1985-01-01
1986-01-01
1987-01-01
1988-01-01
1989-01-01
1990-01-01
1991-01-01
1992-01-01
1993-01-01
1994-01-01
1995-01-01
1996-01-01
1997-01-01
1998-01-01
1999-01-01
2000-01-01
2001-01-01
2002-01-01
2003-01-01
2004-01-01
2005-01-01
2006-01-01
2007-01-01
2008-01-01
2009-01-01
2010-01-01
2011-01-01
2012-01-01
2013-01-01
2014-01-01

5675.4
5937.0
6267.2
6466.2
6450.4
6617.7
6491.3
6792.0
7285.0
7593.8
7860.5
8132.6
8474.5
8786.4
8955.0
8948.4
9266.6
9521.0
9905.4
10174.8
10561.0
11034.9
11525.9
12065.9
12559.7
12682.2
12908.8
13271.1
13773.5
14234.2
14613.8
14873.7
14830.4
14418.7
14783.8
15020.6
15354.6
15583.3
15961.7

g (GDP(t) - GDP(t-1))/GDP(t-1)
g (LN GDP(t) - LN GDP(t-1))Pseudo GDP (Q2 part c) Pseudo GDP (Q2 part d)
8.6
8.6
4.609366741
4.5062909823496300
8.7
8.7
5.561731514
5.4125728640890700
8.7
8.7
3.17526168
3.1258925919274800
8.8
8.8
-0.24434753
-0.2446465460030470
8.8
8.8
2.593637604
2.5605733167584100
8.8
8.8
-1.910029164
-1.9285058732851500
8.8
8.8
4.632354074
4.5282630185639100
8.8
8.8
7.258539458
7.0071990638121300
8.9
8.9
4.238846946
4.1514685234117700
8.9
8.9
3.512075641
3.4518092768147200
9.0
9.0
3.461611857
3.4030457982176200
9.0
9.0
4.20406758
4.1180978844364400
9.0
9.0
3.680453124
3.6143417016026200
9.1
9.1
1.918874624
1.9006964020675800
9.1
9.1
-0.073701843
-0.0737290157061921
9.1
9.1
3.555942962
3.4941792402385400
9.1
9.1
2.745343492
2.7083347545556100
9.2
9.2
4.03739103
3.9580177676185700
9.2
9.2
2.719728633
2.6834012136079700
9.2
9.2
3.795652003
3.7253895648516900
9.3
9.3
4.487264464
4.3895006828087400
9.3
9.3
4.449519253
4.3533699347627000
9.4
9.4
4.685100513
4.5786615293470900
9.4
9.4
4.092525216
4.0109983170951900
9.4
9.4
0.975341768
0.9706160132235910
9.4
9.4
1.786756241
1.7709813800991000
9.5
9.5
2.806612543
2.7679489316208000
9.5
9.5
3.785669613
3.7157717533844400
9.5
9.5
3.344828838
3.2901063454740900
9.6
9.6
2.66681654
2.6318768125836600
9.6
9.6
1.77845598
1.7628264886218000
9.6
9.6
-0.291117879
-0.2915424515117950
9.6
9.6
-2.776054591
-2.8153152912494800
9.7
9.6
2.532128417
2.5006011442357600
9.7
9.6
1.60175327
1.5890605606529100
2.223612905
2.1992511131120600
1.489455929
1.4784724619922000
2.428240488
2.3992274613066300

AVG (All years)

Correlation

g (GDP(t) - GDP(t-1))/GDP(t-1)
g (LN GDP(t) - LN GDP(t-1))
2.777360788
2.721186993
0.999888432

Avg using LN GDP

LN GDP
3.1079145393209900

9.700587268

AVG g between 1976-2007 GDP in 2010

3.171990045
16334.44716
Growth rate required to get back to trend
0.1243060136072440
8$

9.8$
9.7$

6$

9.6$

4$

g$(GDP(t)$;$GDP(t;1))/
GDP(t;1)$

2$

;2$
;4$

1976;01;01$
1979;01;01$
1982;01;01$
1985;01;01$
1988;01;01$
1991;01;01$
1994;01;01$
1997;01;01$
2000;01;01$
2003;01;01$
2006;01;01$
2009;01;01$
2012;01;01$

0$

g$(LN$GDP(t)$;$LN$
GDP(t;1))$

9.5$
9.4$
9.3$
9.2$

Pseudo$GDP$(Q2$part$
c)$
Pseudo$GDP$(Q2$part$
d)$