Financial Modelling and Business Forecasting

5

Gross DomesticProduct (GDP) is among the indicators used in gauging the health ofthe economy of a country(Thurow 1992, p. 102).It is a representation of total dollar value for all the goods andservices that a country produces within a specific period of time. Itdepicts the size of an economy. GDP is in most cases expressed ascomparison to previous year or quarter of a year. GDP can beestimated on expenditure basis to determine amount of money spent, onoutput basis to investigate the quantity of goods and services sold,or on income basis to determine the profit or income that was earned(Thurow 1992, p. 103).

The most commonlyused data is for periods to periods output and consumption changes inreal adjusted or inflated terms. The GDP data reflects the status ofeconomy of a certain section(Baten 2016, p. 56).For instance, for healthy economy, there is a high increase in wagesand employment to meet the needs of the growing economy. This is wellpresented through economic shocks and lags.

An economic shockrefers to the unpredictable and unexpected event that impacts aneconomy either negatively or positively. Technically, it reflectsunpredictable change in the exogenous factors that can have effectson the endogenous economic variables. On the other hand, the timethat a central bank or government takes to respond to the shock in aneconomy is referred to as economic lag. Lag can negatively affect theeconomics of a country as it delays the time between problemidentification and formulation of a solution within an economy. Itcan either be an outside or inside lag referred to as external andinternal lag respectively. Their difference is majorly political andtheir effects to the economy are varied(Capie and Webber 2013, p. 1870).

In short, among thevarious economic indicators, GDP is a good representation of theeconomic activities in a country despite the fact that it does notreflect actual living standards of the citizens. Nevertheless,quarterly GDP is an excellent representation of the economic strengthof a particular country (Capieand Webber 2013, p. 1872).

This paper comparesthe similarities and differences in quarterly GDP for four countriesUSA, Germany, Japan and United Kingdom. The first section involvescomparing the values calculated with the ones gotten from the modelby Fabio and Jane 1998 section three for USA, Germany and Japan forthe period between 1960 and 1994, then getting the values from 1995to 2015.

PART A

Analysis of Data for the period between1960:1 and 1994:4 based on model by Fabioand Jane

In the model by Fabioand Jane 1998, p. 139, the quarterly GDP was used for the period 1960to 1994 for three countries USA, Germany and Japan. The quarterlydata was taken from the OECD database. The slope coefficients for thedeterministic time trends of the values were 0.008 for USA, 0.0077for German and 0.016 for Japan. As it can be seen, the slope forJapan is considerably higher than for USA and Germany. It can beestimated that the VAR has 5 lags and log constants for the detrendedoutputs. The model uses this particular formulae which depicts thefact that each of the countries is populated by very large number rodidentical agents and the labour is assumed to be immobile across thecountries. The preference of the countries being represented are inh,h=1…N.

It is important tonote that the government expenditure yields the utility directly,which is a representative agent of the country, the consumption ofgoods within a country is developed according to the formulae:

Where

This is arepresentative of the Hicks-Neutral deterministic technologicalprogress. The production is subject to the advancement of technologywhich demands domestic labour which adds up toN intermediateinputs in terms of capital. The intermediate capital goods can beaccumulated with the formulae:

Where represents the cost in country h of making use of the capital inputsthat have been created within the country and satisfies the fact that

As it can beobserved, the output shocks in USA have considerably large andpositive effects internationally. For German and Japan, this does nothold. The transmission of a shock across countries takes time andreturn to trend line is slow. For instance, peak response for theoutput lags in Germany lags the output shock from US by threequarters while the Japanese peak response for the output lags byeighteen quarters. The cycle duration is different as it depends onshocks’ origin. This is best illustrated through the US shocks thatare capable of generating fluctuations that can last for between 4and 6 years, and the output shocks from Japan produces irregular andvery short cycles (Fabian &amp Jane 1998, p. 139).

It can be concludedthat there exists an international transmission for the disturbanceswith exception of the output shocks from United States. The outputshocks from United States are a major driver to the internationalcycle and this lenders credence to popular arguments by the pressthat the economy in United States acts as locomotive the globaleconomy. The output shocks from Germany tend to crowd the foreignoutputs during medium run. The output shocks from Japan appear tohave very modest international effects.

Comparison between the USA, Germany andJapan

Period: 1960:1 – 2015:3, quarter GDP data for US, Germany, Japanand China

When comparing GDP for the three countries,a great change is observed between the trends obtained from theperiod between 1995:1 and 2015:3. This is very similar to the valuesobtained by the Fabioand Jane’s model, where the average slope coefficients for thedeterministic time trends were 0.008 for USA, 0.0077 for Germany and0.016 for Japan for the period between 1960:1 and1994:4. As it can beobserved, the values for Japan are extremely high, with a veryconspicuous difference from the trend for USA and Germany. TheJapanese economy was growing at a very high rate when compared toother values. The period between 1960:1 and1994:4 had Japaneseeconomy being the highest of the three countries while in the periodbetween 1995:1 and 2015:3, the GDP in United States was the highest.This is as shown in the figure below.

The high GDP in Japan could have been as aresult of post-war education system that played a major role inmodernizing the factors of production (Persson and Sharp 2015, p.79). This made Japan to be crowned as the first country in the worldwith the highest level of literacy and very high education standards.The Japanese devoted themselves to rebuilding the lost industrialcapacity by making major investments in iron and steel, chemicalfertilizers, electric power and coal. This saw the GDP expanding by 9percent per year from the period between 1960 and 1965 withinfrastructure contributing 12 percent, construction 11 percent andmanufacturing 13 percent. About 41 percent of the total workforcecame from these sectors. This ushered a new industrial developmentwith the Japanese economy opening to international competition(Schumacher and Breitung 2008, p. 386).

Japan experienced severe recession in mid1970s due to world oil crisis. This is well reflected in the figureabove. Japan experienced a decline in the industrial production andfaced severe price inflation. On the other hand, the economy inUnited States and Germany did not have as much significant growth asthe Japan. This was mainly propelled by several factors. Forinstance, in United States, the period between 1960 and 1961 wascharacterized by recession by mid-1962 John F Kennedy tried tosought remedy for American economy through tax relief stimulation.This saw the inflation stabilizing in 1963 and the country recordedhigh corporate profits with a rebound in stock market. Nevertheless,this could not have reached the level for Japan as the rate ofunemployment in USA between 1960:1 and 1994:4 was considerably lowerthan that of Japan 5.7 percent per year compared to Japan at 42percent per year. In overall, while the employment in USA was growingat an approximate rate of 4 percent, in Japan, employment growth ratewas 42 percent per year hence the huge differences in GDP trends.Germany experienced similar challenges after war and had to invest alot of money in rebuilding the economy.

Generally, the huge differences can beattributed to the fact that Japan did not experience liberalism andcompetition as USA and Germany had. However, after the massive shockcaused by oil prices, Japan was unable to pick-up from the structuraleconomic changes, though the growth was higher, at 5 percent comparedto 3.7 percent of the United States(Schumacherand Breitung 2008, p. 387). However,in the period between 1995:1 and 2015:3, the economic growth in USAwas considerably higher than in Japan. Itcan be seen that the growth of USA and Germany in the period between1995: 1 and 2015:3 is considerably higher than in the period between1960:1 and1994:4. The slope coefficients for deterministic timetrends are 0.0059 for USA, 0.0032 for Germany and 0.0021 for Japanfor the period from 1995: 1 to 2015:3 compared to the values in theperiod between 1960:1 to 1994:4 0.008 for USA, 0.0077 for German and0.016 for Japan.

Nevertheless, despite of countries facingmajor drawbacks such as crisis in world oil prices, the trends inincrease and decrease in GDP are the same though at different rates.This is an implication that over the years, all the three countrieshave been working towards attaining a better economy.

Period: 1995:1 – 2015:3

Economic outlook for the three countrieshas improved significantly since 1995 despite the huge differences inthe rate of improvement and development. This is presented in thefigure below.

The GDP for the three countries variedsignificantly, though the trends over the years are almost similar.For instance, from 1995 to 1996, the economy grew substantially inthe three countries. This was followed by a drastic fall in economyin Japan, slight increase in Germany and relatively stable economy inUSA. Some notable effects in similarities include the period between2007 and 2008, and the period between 2010 and 2012 when thequarterly GDP for the three countries fall drastically. Japan andUSA were the most affected by the fall in economy. This was probablybecause of the economic recession that hit many parts of the world(Bhar and Hamori 2003, p. 223).

From the economic shocks of the threecountries, it can be seen that the lag in Germany is higher than inJapan and USA. For instance, in 2008, the economy decreaseddrastically as witnessed by the negative trends in quarterly GDP.However, it took one year for the economy to go back to zero in USAand Japan but for Germany the recovery was more than one year. Thiscould have been because of the decrease in GDP in Japan in the periodbetween 2013 and 2014 which meant that it made considerable effortsfor the economy to rise again in the period between 2014 and 2015.This is witnessed by a huge rise in trend for Japan between 2014 and2015, which is the highest among the three countries(Walton and Rockoff 2013, p. 307).

As per the 2015 ranking, USA leads inquarterly GDP, followed by Germany and finally Japan. In terms ofdevelopment, it can be concluded that a country has to incur a lot ofexpenses so as to establish a development basis as is the case forGermany. In overall, the GDP for Germany has been at the lowestlevel compared to United States and Japan. On the other hand, Japanhas experienced an almost constant increase in produce with exceptionof some few instances when even all the other countries experiencedeconomic hitch. Such behaviour in economy is a reflection ofincreased growth in an economy, and consequently high livingstandards of the people (Persson and Sharp 2015, p. 78).

For United States, the economy seems to beperforming comparatively better than for both Japan and Germany. Thisis with exception of the period between 2010 and 2012 when USA wasthe hardest hit by the economic recession. Otherwise, the growth ineconomy in USA has always been higher than for both Japan and Germanyas can be seen from the trends in GDP. This would be probably becausethe country developed long time ago hence, most of her revenue isnot used in establishing the basis for development.

Period: 1960:1 – 1994:4 quarter GDP data for US, Germany andJapan

The similarities and differencesbetween the findings of Jane and Fabio and the findings of our report

Similarities

Our findings on the slope coefficients ofdeterministic time trends between the three countries were the sameas those that were found by Fabio and Jane in their journal ofinternational economics. Jane and Fabio found that the slopecoefficients of the countries were 0.008, 0.0077 and 0.0016 forUnited States, japan and Germany respectively for the years between1960:1 and1994:4.

Another clear similarity between ourfindings and that of Jane and Fabio is the fact they the outputshocks of the united states that have a significant large andpositive impacts on the entire output of the world. In both of theresults, it is clear that these results are only experienced throughthe output of the United States and not the other two countries.

The results obtained by Jane and Fabioconcerning the economic outlook of the three countries are similar tothe results that we have obtained in our analysis, in both there agreater improvement since the year of 1995 due to various economicdevelopments.

Differences

The model used by Jane and Fabio uses allthe capital obtained both from the foreign sources while the data andthe results that we have obtained in our analysis is based mainly onthe domestic capital. The development of varied domestictechnological disturbance brings a lot of differences in the valuesthat we have obtained.

Another major difference between theresults obtained by Fabio and Jane and the data that we have obtainedis the VAR lags values. Fabio and Jane estimated the VAR lags to beabout 9 lags but in our studies, we have obtained the variance lagsto be about 5 lags which is also constant on the logs detrendsoutputs and the reports of the responses.

PART B

Comparison for all countries

The trend in quarterly data is as shownbelow.

Taking the fourth country to be UnitedKingdom, similar analysis is carried out. The comparison is as shownin the table below.

The OECD data on quarterly GDP shows thatthe economy in UK has been growing a similar trend with Japan but ata relatively higher rate than Japan. The United Kingdom appears tohave the highest GDP over the entire period 1960:1 to 2015:3.Nevertheless, during economic downturns, the UK economy appears to bethe most affected in terms of GDP. Nevertheless, from 1960s up to2015: 3, the GDP in UK seems to be decreasing, probably because ofthe decline in manufacturing. The share of real GDP decreased from 30percent in 1970s to 12% towards the end of 2010(Baten and Schulz 2005, p. 34)This trend has also been seen in all the other three countries.

Among the major factors that contributed tothe increase in GDP in UK was global economic boom that saw therecovery of economies such as Germany and Japan. This made UK enjoy aperiod of continuous growth in trade and economy. The increasedimmigration also increased the number of working population, hencethe increase in real GDP. The improvement in secondary and Universityeducation also played a major role towards the growth of UK economy(Baten and Schulz 2005, p. 34).For the whole period, the slope coefficient for deterministic timetrends were highest for USA, followed by UK, Germany and Japan0.0059, 0.0053, 0.0032 and 0.0021 respectively

Similarities and differences betweenfindings in parts A and parts B

Similarities

From the results that we have obtained onafter introducing Germany in our analysis has a number ofsimilarities with the initial findings which include the fact thatthere is a similar economic trends that have been observed over theyears. Our findings on the slope coefficients of deterministic timetrends for both the first and the second parts are similar.

There is also a similarity in the fact thatthe output shocks of the United States have a significant large andpositive impacts on the entire output. The output shock that the UKhave on the results that not show any significant change on thevalues that are obtained from the other countries as shown in theresults.

Differences

The results after incorporating GDP theUnited Kingdom in the analysis does show very small difference. TheGDP for the countries have been affected by the output shock of theUnited Kingdom and this is a major difference in the fluctuationsthat help in forecasting.

Another major difference is in the he slopecoefficient for deterministic time trends which were highest for USA,followed by UK, Germany and Japan 0.0059, 0.0053, 0.0032 and 0.0021.in the results of part A we can see the results to be 0.008, 0.0077and 0.0016 for United States, japan and Germany respectively, thisdepicts and big difference.

Conclusion

Economic development can be considered as along-term activity. This is well illustrated in the analysis ofquarterly GDP for countries. The rate of growth of GDP for the fourcountries is different. This is major because of the variation ineconomic shocks and differences in economic lags. This implies thateach country should be vigilant to ensure that the GDP growth is highdespite the economic challenges that it may experience. Nevertheless,the economic growth of big global players such as Japan and Germanywill have direct impact on growth of others such as USA and UK.

Reference List

Baten, J. ed., 2016. AHistory of the Global Economy.Cambridge University Press.

Baten, J. and Schulz, R., 2005. Makingprofits in wartime: corporate profits, inequality, and GDP in Germanyduring the First World War1. TheEconomic History Review, 58(1),pp.34-56.

Bhar, R. and Hamori, S., 2003. Alternativecharacterization of the volatility in the growth rate of real GDP.Japan and the World Economy,15(2),pp.223-231.

Capie, F. and Webber, A., 2013. AMonetary History of the United Kingdom: 1870-1982.Routledge.

Fabian, C., &amp Jane, M. 1998. Sources and propagation of international output cycles: common shocks or transmissions? Journal of International Economics 46 , pp. 133-166.

Persson, K.G. and Sharp, P., 2015. Aneconomic history of Europe.Cambridge University Press.

Thurow, L.C., 1992. Headto head: The coming economic battle among Japan, Europe, and America.Granite Hill Publishers.

Schumacher, C. and Breitung, J., 2008.Real-time forecasting of German GDP based on a large factor modelwith monthly and quarterly data. InternationalJournal of Forecasting, 24(3),pp.386-398.

Walton, G. and Rockoff, H., 2013. Historyof the American economy. CengageLearning.

When comparing GDP for the three countries,a great change is observed between the trends obtained from theperiod between 1995:1 and 2015:3. This is very similar to the valuesobtained by the Fabioand Jane’s model, where the average slope coefficients for thedeterministic time trends were 0.008 for USA, 0.0077 for Germany and0.016 for Japan for the period between 1960:1 and1994:4.