In this lesson, students explore the advance estimate of real GDP data for the fourth quarter of 2014. These data, released by the Bureau of Economic Analysis, are presented first as estimates, then as revisions as more data for the time period is collected. This lesson uses data from the initial estimate of the 4Q 2014 activity. Students will understand the recent trends in real GDP, the role of currency valuation in affecting GDP, and some of the other consequences of a strong dollar in terms of influencing economic variables.

KEY CONCEPTS

Balance of Trade, Exchange Rate, Exports, Gross Domestic Product (GDP), Imports, Macroeconomic Policies, Macroeconomics, Net Exports, Real Gross Domestic Product (GDP), Value of Money

STUDENTS WILL

  • Analyze the components of the latest GDP report
  • Compare the estimate to the predicted GDP growth and to the previous quarter's performance
  • Understand the role the value of currency plays in determining GDP
  • Discuss other consequences of currency valuation in influencing economic outcomes

Current Key Economic Indicators

as of March 7, 2015

Inflation

The Consumer Price Index for All Urban Consumers (CPI-U) declined 0.7% in January on a seasonally adjusted basis. Over the last 12 months, the all-items price index fell 0.1%, the first 12-month negative change since the period ending October 2009. The gasoline index fell 18.7% and was the main cause of the decrease in the seasonally adjusted all items index. Core inflation rose 0.2% in January.

Employment and Unemployment

The unemployment rate fell to 5.5% in February of 2015, according to the Bureau of Labor Statistics release of March 6, 2015. Total nonfarm employment rose by 295,000. Job gains were particularly strong in food services and drinking places, professional and business services, and construction. Manufacturing employment also increased, although not as much as last month.

Real GDP

Real GDP increased 2.2% in the fourth quarter of 2014, according to the revised estimate released by the Bureau of Economic Analysis. This estimate is 0.4 percentage points less than the advance estimate. Consumer spending rose 4.2%, along with business investment, exports, and state and local government spending. Offsetting these gains were increases in imports and decreases in federal government spending.

Federal Reserve

In its January 28, 2015, statement, the FOMC cited the continued growth of the labor market, increased household and business spending, and below-target inflation as indicators of an economy that continues to recover. They expect below-target inflation to rise as oil prices and other "transitory" effects diminish. The statement reaffirmed the FOMC intention to keep the federal funds rate at its current low level. Notably, the FOMC added international variables to its list of factors to monitor for the timing of a rate increase.

INTRODUCTION

The Bureau of Economic Analysis, an agency of the U.S. Department of Commerce, releases an  estimate of each quarter's real GDP, one of the major components of economic activity. In the first month following the end of a quarter, the "advance" or first estimate, is released. In the second month following the end of a quarter, this estimate is revised using additional information. Finally, in the third month, the final data are released. This means that a report is released once a month but real GDP is measured quarterly.

This lesson focuses on the BEA's second, or revised estimate of real GDP for the 4th quarter of 2014 (October-December). Students investigate the relationship between currency values and GDP. Because the value of imports is a subtraction from GDP, the strength of the dollar significantly affects not only GDP, but also the rate of inflation.

RESOURCES


Key Economic Indicators

as of March 7, 2015

Inflation

The Consumer Price Index for All Urban Consumers (CPI-U) declined 0.7% in January on a seasonally adjusted basis. Over the last 12 months, the all-items price index fell 0.1%, the first 12-month negative change since the period ending October 2009. The gasoline index fell 18.7% and was the main cause of the decrease in the seasonally adjusted all items index. Core inflation rose 0.2% in January.

Employment and Unemployment

The unemployment rate fell to 5.5% in February of 2015, according to the Bureau of Labor Statistics release of March 6, 2015. Total nonfarm employment rose by 295,000. Job gains were particularly strong in food services and drinking places, professional and business services, and construction. Manufacturing employment also increased, although not as much as last month.

Real GDP

Real GDP increased 2.2% in the fourth quarter of 2014, according to the revised estimate released by the Bureau of Economic Analysis. This estimate is 0.4 percentage points less than the advance estimate. Consumer spending rose 4.2%, along with business investment, exports, and state and local government spending. Offsetting these gains were increases in imports and decreases in federal government spending.

Federal Reserve

In its January 28, 2015, statement, the FOMC cited the continued growth of the labor market, increased household and business spending, and below-target inflation as indicators of an economy that continues to recover. They expect below-target inflation to rise as oil prices and other "transitory" effects diminish. The statement reaffirmed the FOMC intention to keep the federal funds rate at its current low level. Notably, the FOMC added international variables to its list of factors to monitor for the timing of a rate increase.

PROCESS

  1. Have students look at the revised fourth quarter report of real GDP for 2014.

    How much did the economy grow in the fourth quarter according to the revised estimate? (2.2%) What was the advance estimate for the fourth quarter? (2.6%
  2. Which components of GDP increased the most in the fourth quarter? (consumer spending, business investment, exports, state and local government spending. Imports also increased, which is a subtraction from GDP). What components decreased? (federal spending, esp. on defense)
  3. Hold up a dollar and ask students how much they would be willing to pay to buy it (they will probably look at you like you are slightly crazy; some may give you wild answers). Tell students that this question doesn't make much sense when you think of buying a dollar and paying for it with U.S. currency--a dollar is worth a dollar. But this is a serious question when we talk about buying a dollar and paying for it with the currency of another country. Then the question of how much a dollar is worth is very important to our GDP.
  4. Ask students why people in other countries would want to buy dollars--because they're attractive? these people are collectors? will they hang them on their walls? (with repeated silly suggestions, students should begin to get the idea that people in other country want dollars so they can buy American-made goods and services with them).

    Ask students, what do we call it when people are able and willing to pay for something--what concept is that? (it's a demand relationship). Tell students that currency has a market just like anything else, complete with demand and supply. 
  5. Tell students that the price of one currency in terms of another one is called the exchange rate. Give students an example of different "prices" of a dollar. For example, assume that the exchange rate between a dollar and the British pound is $1 = £0.65. Or looked at another way, £1 = $1.54 (dividing 1 by 0.65)

    T
    ell students that means that if they were in England and saw something for sale for £10, that would be the same as paying $15.40 for it with U.S. currency.

    Ask them if they would be happy if instead of $1 = £0.65, $1 = £0.80? (they should say yes--they are getting more pounds for the same $1). Again, the other way of looking at this exchange rate is £1 = $1.25 (dividing 1 by 0.8), so that item that costs £10, now is the same as paying $12.50 (instead of $15.40).
  6. Tell students that when $1 buys more of another currency (as in the previous example), we say that the value of the dollar is rising compared to whatever the other currency is--in this case the British pound. In other words, the dollar is strong compared to the pound.

    Tell students that if the sequence of events had been reversed--the dollar started off being worth £0.8 and then went to £0.65, that would mean that the dollar is worth less--the dollar is weakening compared to the pound.

    Tell students that because currency is bought and sold in a market just like anything else, the value of a dollar varies a lot over time:

     
    Value of Dollar to British Pound
  7. Ask students if they think having a strong dollar or a weak dollar is better for the economy (they will probably say that having a strong dollar is better). Tell them that in general, they are correct--a strong dollar is an advantage for our economy because it means that American consumers benefit from lower-priced imports. It's also a general sign that our economy is growing.
  8. Remind students of why someone living in another country would want dollars (to buy American-made goods). Ask students if a strong dollar is good for everyone (they should recognize that it is not good for people living in other countries who buy American-made products). Ask students what they think will happen to the demand for American-made products if the dollar is strong (demand will go down). Ask students what that will mean for the U.S. (a strong dollar means that exports will decrease and imports will increase, in general).
  9.  Ask students what effect a strong dollar has on GDP (because exports fall and imports increase, the net effect on GDP would be negative). Ask students again if a strong or weak dollar is better for the economy (they might start expressing some reservations about their previous answer). 

    Ask students what would happen in our economy if consumer expenditure suddenly increased a lot (GDP would increase, creating inflationary pressure on the economy). Ask students if there is a way for consumer expenditure to increase without creating the same level of risk of inflation (if consumers direct their spending on imports instead of American-made products, the risk of inflation is lowered). Tell students that this is another advantage of a strong dollar--we can consume more products without creating as large of an inflationary risk because we're consuming imported goods.

ASSESSMENT ACTIVITY

CONCLUSION

Real GDP data are released monthly, but are reports of quarterly activity. One month after the end of a quarter, the first ("advance") report is released. As more data come in, the second report is issued at the end of the second month from quarter's end, with the "final" or third report coming at the end of the third month from the end of the quarter. These three reports, while all containing data pertaining to one quarter, represent progressively more accurate accounting of what activity actually happened in the quarter. 

The strength of the dollar significantly affects GDP through its impact on net exports. A strong dollar means that American products are expensive for those in other countries, while imported goods are cheaper for American consumers. However, a growth of imports represents a subtraction from GDP. A strong dollar also can serve as a pressure valve on inflation, as American consumers can exhibit strong demand for goods and services without all of that demand pushing up inflation--i.e., some of that demand can be channeled to imports if a strong dollar makes them relatively less expensive, which does not put the same pressure on inflation.

EXTENSION ACTIVITY

Tell students that sometimes countries try to weaken their currencies. Ask why a country might want to do so (to encourage other countries to buy their exports, to try to encourage economic growth).

Who are the winners and losers in this case? (domestic consumers lose, at least in the short run; exporting industries win).

EDUCATOR REVIEWS