In this issue, the Mississippi Business Journal begins a series of columns on tracking the national economy. Each article will focus on a specific key “economic indicator” and the information that it provides that helps us understand what the future may bring. We have no illusions about the difficulty of predicting something as large and complex as the national economy, but as the old adage goes: “In the land of the blind, the one-eyed man is King.” We begin the series with an article on what we are trying to forecast: specifically GDP.
The desire to understand what the future may hold appears to be a basic human trait. We abhor uncertainty, and are always seeking ways to reduce the risk of uncertainty to our businesses and our personal lives.
Our goal in this series is to inform the reader about selected economic indicators and what light they can shed on the future of the economy.
The U.S. economy is currently some $12 trillion (GDP) and, by that measure, the largest economy in the world. At any given time, this economic goliath has significant momentum, and changes in both the speed and direction of the economy are slow in developing. By watching selected economic indicators, we may see forces developing that could result in changes to either the speed or direction of the economy.
As we watch GDP (or any other dollar series) over time, it is important to watch “real growth” or growth after adjusting for price level changes (inflation).
Why are there business cycles?
If GDP simply grew steadily, there would be little interest in tracking indictors to predict the future. However, since the end of World War II, there have been 10 economic contractions (peak to trough) varying from six to 16 months.
The most recent contraction (2000-2001) is easily seen in the chart. These “cycles” can leave businesses with excess inventories when they fail to see the downturn and lost business when they fail to see a recovery.
If businesses, consumers and governments can anticipate the cycles properly, it can smooth out these fluctuations and reduce the risks of both excess inventories and shortages.
What is GDP?
What makes your business successful is your customers spending money with you. You refer to that spending as revenue and, if you want to measure the size of your business, total revenue or sales is one measure you could select.
At the national level, we also measure the total spending (making allowances so that we do not double count the production of parts and the production of the final good as well) and refer to the total of that spending as Gross Domestic Product (GDP).
In all transactions, the party spending the money creates “income” to the party receiving the money. Thus we can measure the size of your business by either adding up all of your revenues (customer expenditures) or by adding up where all of your income went (wages, interest, profits, etc.). We would get the same answer either way. The same is true for the national economy. It is the federal government’s responsibility to tally these expenditures and income payments and report quarterly on their respective sizes in the GDP reports. These accounts, known as the National Income and Product Accounts or NIPA, are maintained by the Bureau of Economic Analysis of the U.S. Department of Commerce and can be found at www.bea.gov. As we explore various economic indicators, our focus is on how these indicators can provide important clues regarding any possible changes in the level of expenditures for the future.
Four categories of expenditures
There are four basic groups whose expenditures collectively constitute the nation’s gross domestic product: consumers, businesses, governments and foreigners. These expenditure categories are thus (1) consumption, (2) investment, (3) governments spending and (4) net exports (net of imports). Think of economic indicators as providing you with some information about the intentions (or abilities) of these groups to continue their expenditure patterns into the future.
These four groups vary in size and in volatility. Consumption is the largest group, accounting for an average of 68% to 70% of all expenditures in any given quarter. Since it is the largest, there is considerable attention paid to indicators of any change in consumption patterns in the future (e.g., employment, taxes, inflation, interest rates, etc.)
Investment spending and government spending are about the same size, but investment tends to much more volatile than government spending. Net exports are the smallest of the four groups, but it is significant because it is negative and therefore subtracts from the overall expenditure level (GDP) of the economy.
There are three main issues to consider in ranking the importance of these expenditure groups: one is relative size (consumption is the largest); one is relative volatility (investment is the most volatile); one is the direction of impact or sign (net exports are negative and an overall drag on the economy). In other words, consumption is important to monitor because it accounts for two-thirds of total spending; business investment is important because it can change quickly, and net exports are important because they currently exert a large negative affect on the nation’s GDP. While relatively large in size, government spending is not usually monitored on a month-to-month basis since spending is determined in advance by congressional action.
What is a normal GDP growth rate?
The “trend” growth rate of GDP depends fundamentally on two things: growth in the labor force and growth in productivity. Only if we increase the number of workers in the economy or increase their productivity can we expect GDP to grow.
Given the recent trends in labor force growth and productivity, a growth rate of 3.5% is generally thought of one that would maximize the use of all of our resources. Consistently faster growth would be inflationary, and consistently slower growth would result in growing unemployment.
The most recent GDP growth rate (second quarter 2005) was 3.3%.
What are the indicators that we will examine?
There are literally hundreds of “indicators” of the future behavior of these expenditure groups. Some are important while others are minor. If your curiosity needs satisfying, go to www.nber.com, the site for the National Bureau of Economic Research, and see their list of 132 indicators.
As we begin to explore these indicators, keep in mind that the best indicators are those that are:
• timely with a relatively short reporting lag;
• not typically significant revisions in subsequent months;
• adjusted for changes that impact the quality of the data (storms, changes in number of holidays, differences in trading days in the month, etc.)
Next time, we’ll take a look at the employment situation report.
Dr. William D. Gunther is professor of economics and director of the Bureau of Business and Economic Research in the College of Business at the University of Southern Mississippi. Contact him via e-mail at email@example.com.