Announcement

Real Gross Domestic Product (GDP) during the third quarter (July through September) of 2001 decreased at an annual rate of 0.4 percent. This is the "preliminary" estimate for the second quarter. The estimate is based on incomplete data and will be revised in the coming months. During the first and second quarters of 2001, real GDP increased at an annual rate of 1.3 percent and 0.3 percent respectively. For the year 2000, real GDP increased at annual rates of 2.3, 5.7, 1.3, and 1.9 percent in each of the four quarters. The slowing rate of growth throughout 2000 has continued through 2001. The growth rate in real GDP over the last 12 months has been 0.8 percent. That compares with a more than 4 percent annual growth rate over the last several years.

Why are Changes in Real Gross Domestic Product Important?

The measurement of the production of goods and services produced each year permits us to evaluate our monetary and fiscal polices, our investment and saving patterns, the quality of our technological advances, and our material well-being. While rates of inflation and unemployment and changes in our income distribution provide us additional measures of the successes and weaknesses of our economy, none is a more important indicator of our economy's health than rates of change in real GDP.

Changes in real GDP are discussed in the press and on the nightly news after every monthly announcement of the latest quarter's data or revision. Real GDP trends are prominently included in discussions of potential slowdowns and economic booms. They are featured in many discussions of trends in stock prices. Economic commentators use falls in real GDP as indicators of recessions. The most popular (although inaccurate) definition of a recession is at least two consecutive quarters of declining real GDP.

Most important, changes in real GDP per capita provide our best measures of changes in our material standards of living.

Definition of Gross Domestic Product

Gross Domestic Product (GDP) is one measure of economic activity, the total amount of goods and services produced in the United States in a year. It is calculated by adding together the market values of all of the final goods and services produced in a year.

  • It is a gross measurement because it includes the total amount of goods and services produced, some of which are simply replacing goods that have depreciated or have worn out.
  • It is domestic production because it includes only goods and services produced within the U.S.
  • It measures current production because it includes only what was produced during the year.
  • It is a measurement of the final goods produced because it does not include the value of a good when sold by a producer, again when sold by the distributor, and once more when sold by the retailer to the final customer. We count only the final sale.

Changes in GDP from one year to the next reflect changes in the output of goods and services and changes in their prices. To provide a better understanding of what actually is occurring in the economy, real GDP is also calculated. In fact, these changes are more meaningful, as the changes in real GDP show what has actually happened to the quantities of goods and services, independent of changes in prices.

Data Trends

The growth in real GDP over the past few years has been relatively high when compared with the early part of the 1990s. However, during the last two quarters of 2000 and the first three quarters of 2001, the rate of growth of real gross domestic product slowed tremendously. During the third quarter of 2001, real GDP was actually negative for the first time since 1993, reinforcing concerns that our economy is headed into a recession. The last recession began in July of 1990 and continued through March of 1991.

The Federal Reserve has responded to slowing growth and the potential of recession by reducing the target federal funds rate by 400 basis points (4.0%) from January 2001 to October 2001. (See the May Federal Reserve System and Monetary Policy case and the upcoming October 2 Federal Reserve case.)

The price index for GDP increased at an annual rate of 2.1 percent in the third quarter of 2001, compared to 2.3 percent for 2000.

Figure 1: Quarterly Changes in Real GDP at Annual Rates (1990-2001)

The rate of increase in real GDP has been higher in the last several years than in the first part of the 1990s and much of the 1970s and 1980s. Economic growth, as measured by average annual changes in real GDP, was 4.4 percent in the 1960s. Average rates of growth decreased during the 1970s (3.3%), the 1980s (3.0%), and the first half of the 1990s (2.2%). In the last five years of the 1990s, the rate of growth in real GDP increased to 3.8 percent, with the last three years being over 4.1 percent per year.

Figure 2: Annual Percentage Changes in Real GDP (1970-2000)

The upward trend in economic growth over the past decade has been accompanied by increases in the rates of increase of consumption spending, investment spending, and exports. Productivity increases, decreases in unemployment, expansion in the labor force, and increases in the amount of capital have allowed real GDP to grow at the faster rates. During this same time period, consumers have reduced their savings.

Details of the Second-Quarter Changes in Real GDP

Real GDP in the third quarter fell from its level in the second quarter of 2001. Personal consumption expenditures and government spending increased during the third quarter. However, these increases were offset by a deceleration in residential fixed investment and business purchases of equipment and software. Imports, which are subtracted from real GDP, decreased, but exports, which are added to real GDP, decreased by a greater amount. Thus the effect of the changes in net exports was to increase spending in the economy.

Consumers continued to increase spending, but at a slower rate of increase. Real consumption spending increased at an annual rate of 1.2 percent, as compared to 3.5 percent for the previous three quarters. There is indication that the growth in consumer spending slowed each month during the quarter.

Real investment decreased at an annual rate of 10.1 percent during the third quarter, compared to a decrease of 12.1 in the second quarter. The largest part of the decrease in investment spending was due to a reduction in residential and non-residential fixed investment, such as equipment and software. Businesses continued to reduce their inventories.

Exports decreased by 16.6 percent (compared to a decrease of 11.9 percent in the second quarter) and imports decreased by 15.2 percent (compared to a decrease of 8.4 percent in the second quarter). Thus net exports fell during the quarter.

Real government spending increased at an annual rate of 1.8 percent.

The slowing growth in spending appears to be caused by consumers reducing the growth in their spending and businesses further reducing the amount of investment spending. Both events result in businesses further cutting investment in equipment and inventories, as not as much of either is needed. Consumers appear to be becoming less confident about the future and possibly will reduce spending in the future.

Monetary policy has been used to encourage consumers to increase spending and businesses to increase investment. In addition, there is much discussion and debate about the effects of the current increase in government spending. The short-run effects of both the monetary policy and the increase in government spending should be some stimulus to spending.

Recessions

Many news reports are discussing issues surrounding the current trends and status of the U.S. economy. Debates are taking place about whether the U.S. economy is currently in a recession or will soon be in a recession. The primary indicator used in those reports is the change in real GDP.

Growth in real GDP has been falling and now has turned into an actual decrease. Real GDP may already have decreased in the third quarter (July through September). The agency that officially defines the start and end of recessions does not use changes in real GDP as the actual determinant, because real GDP data are announced for quarters and are subject to significant revisions. Instead, they use the related measures of levels of employment, real income, industrial production, and real manufacturing and trade sales.

We should be cautious in interpreting this decline as the beginning of a recession. It may well be, however the average revision of the advance GDP estimate is .5%. Thus, an average upward revision would still mean in essence a constant real GDP.

The dating group, the National Bureau of Economic Research, defines a recession as a "significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade." The current data show a decline in employment, but not as large as in the previous recession. Real income growth has slowed but not declined. Manufacturing and trade sales and industrial production have both declined and have been doing so for some time. The National Bureau point to this real decline in the manufacturing sector of the economy as a serious decline, but also emphasize that the rest of the economy has not reflected the traditional signs of a recession.

Current news reports do discuss possibilities of the recent terrorist attacks actually increasing the likelihood of a recession occurring. If that happens, it would be due to falling consumption spending due to declining consumer confidence, declines in industries most directly affected by the terrorism (travel, being a prime example), and further cutbacks in business investment spending.

The last recession began in July of 1990 and ended in March of 1991, a period of eight months. However, the beginning of the recession was not announced until April of 1991 (after the recession had actually ended). The end of the recession was announced in December of 1992, almost 21 months later. One of the reasons the end of the recession was so difficult to determine was the economy did not grow very rapidly even after it came out a period of falling output and income.

Changes in Nominal Gross Domestic Product

Nominal GDP - that is, GDP measured in current prices - increased at annual rate of 1.8 percent in the second quarter to a level of $10,247.7 billion. The difference between the rates of increase in the nominal gross domestic product (1.8%) and the real gross domestic product (-0.4%) is the rate of change in prices of goods and services included in gross domestic product. Those prices are represented by the GDP deflator (or price index), which increased at an annual rate of 2.1 percent (due to rounding, these numbers may not always add up exactly).

A Hint About News Reports

Many news reports simply use "gross domestic product" as a term to describe this announcement. The actual announcement focuses on the REAL gross domestic product, and that is the meaningful part of the report. In addition, newspapers will often refer to the rate of growth during the most recent quarter and will not always refer to the fact that it is reported at annual rates of change. This is contrasted to the reports of the consumer price index, which are reported at actual percentage changes in the index for a single month, and not at annual rates.

How can we increase economic growth in the future?

Explanations of GDP and its Components

It is common to see the following equation in economics textbooks:

GDP = C + I + G + NX

Consumption spending (C) consists of consumer spending on goods and services. It is often divided into spending on durable goods, non-durable goods, and services. These purchases accounted for 69 percent of GDP in the first quarter.

  • Durable goods are items such as cars, furniture, and appliances, which are used for several years (10%).
  • Non-durable goods are items such as food, clothing, and disposable products, which are used for only a short time period (20%).
  • Services include rent paid on apartments (or estimated values for owner-occupied housing), airplane tickets, legal and medical advice or treatment, electricity and other utilities. Services are the fastest growing part of consumption spending (39%).

Investment spending (I) consists of non-residential fixed investment, residential investment, and inventory changes. Investment spending accounts for 17 percent of GDP, but varies significantly from year to year.

  • Non-residential fixed investment is the creation of tools and equipment to use in the production of other goods and services. Examples are the building of factories, the production of new machines, and the manufacturing of computers for business use (14%).
  • Residential investment is the building of a new homes or apartments (4%).
  • Inventory changes consist of changes in the level of stocks of goods necessary for production and finished goods ready to be sold (1%).

Government spending (G) consists of federal, state, and local government spending on goods and services such as research, roads, defense, schools, and police and fire departments. This spending does not include transfer payments such as Social Security, unemployment compensation, and welfare payments, which do not represent production of goods and services (18%).

Net Exports (NX) is equal to exports minus imports. Exports are items produced in the U.S. and purchased by foreigners (11.3%). Imports are items produced by foreigners and purchased by U.S. consumers (15.6%). Thus, net exports (exports minus imports) are negative, about -4% of the GDP. (For more information on the balance of trade, see the Trade Report case study.)

GDP as a Measure of Well-being

Changes in real GDP are a more accurate representation of meaningful economic growth than changes in nominal GDP, because changes in real GDP represent changes in quantities produced, while prices are held constant. Real GDP per capita is even more relevant because it measures goods and services produced per person and thus approximates the amount of goods and services each person can enjoy. If real GDP grows, but the population grows faster, then each person, on average, is actually worse off than the change in real GDP would indicate.

Consider the table below. While the mainland part of China has a real GDP of $991 billion, its real GDP per capita is only $791.30. Hong Kong has a much smaller real GDP of $159 billion. However, its real GDP per capita is much higher at $23,639.58. Other nations, such as France and Germany, may have quite different GDPs, but real GDPs per capita that are very close.

Country Population GDP (billions) Per Capita GDP

China (Mainland)

1,249,671,000

$991.07

$791.30

China (Hong Kong)

6,877,000

$158.61

$23,639.58

France

60,794,000

$1,435.48

$24,593.62

Germany

82,027,000

$2,114.73

$25,782.08

United States

272,878,000

$9,256.15

$33,933.58

1999 Real GDP in billions of current US dollars (International Monetary Fund)


Revisions in GDP Announcements

Real GDP for each quarter is announced three times. The month following the end of the quarter is described as the advance GDP; the second announcement or revision is described as the preliminary announcement; and the third month is the final. While labeled as the final version, even it will eventually be revised after the final data for the year are published. Over the past five quarters, the advance estimates have been revised by +0.1 to -0.7 percent with an average decrease of 0.3 in the rate of growth of GDP and the preliminary estimates have been revised by +0.3 to -0.5 percent with an average decrease of 0.1 in the rate of growth of GDP.

Revisions in inventory investment and the international trade data are often the causes of changes in the GDP figures. Because changes in inventories and international trade data make up significant portions of the current report, one should be particularly cautious in using the "preliminary" figures.

Are estimates of GDP accurate measures of our well-being?

Questions

Components of GDP

Determine if each of the items listed below should be included in GDP and under which component or components: Consumption, Investment, Government, Exports or Imports.

  1. A stereo produced and sold in the US by a Japanese company
  2. College tuition
  3. Social Security payments
  4. Microsoft stock purchased from Microsoft
  5. A space shuttle launch
  6. The purchase of a plane ticket to London on British Airways
  7. The purchase of a US Treasury Bond by an individual
  8. A new factory
  9. The sale of a previously occupied house
  10. A bottle of French wine, sold in the US
  11. A television produced, but not sold.
  12. A home cooked meal
  13. A dinner at a restaurant
  14. A computer produced in the US and sold in Canada
  15. A new interstate

Original US Bureau of Economic Analysis Announcement and Data

www.bea.gov