This lesson focuses on the February 28, 2008, preliminary report on Real Gross Domestic Product (Real GDP), produced by the U.S. Bureau of Economic Analysis (BEA). The current data and historical data are explained. The meaning of GDP and potential impacts of changes of GDP are explored. This Focus on Economic Data will also raise question about the potential for a recession in the United States in 2008.

KEY CONCEPTS

Business, Business Cycles, Demand, Economic Growth, Macroeconomic Indicators, Real vs. Nominal, Standard of Living, Supply

STUDENTS WILL

  • Determine the current and historical growth of U.S. real gross domestic product.
  • Identify the components of the measurement of the nation's gross domestic product.
  • Determine the difference between nominal and real gross domestic product.
  • Speculate about the nature and impact of current economic conditions and implications for the future.

Current Key Economic Indicators

as of May 5, 2013

Inflation

On a seasonally adjusted basis, the Consumer Price Index for All Urban Consumers decreased 0.2 percent in March after increasing 0.7 percent in February. The index for all items less food and energy rose 0.1 percent in March after rising 0.2 percent in February.

Employment and Unemployment

Total nonfarm payroll employment rose by 165,000 in April, and the unemployment rate was little changed at 7.5 percent. Employment increased in professional and business services, food services and drinking places, retail trade, and health care.

Real GDP

Real gross domestic product increased at an annual rate of 2.5 percent in the first quarter of 2013 (that is, from the fourth quarter to the first quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the fourth quarter, real GDP increased 0.4 percent.

Federal Reserve

To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent...

INTRODUCTION

This lesson focuses on the February 28, 2008, preliminary report on Real Gross Domestic Product (Real GDP) for the fourth quarter of 2007 (Q4), produced by the U.S. Bureau of Economic Analysis (BEA). The current data and historical data are explained. The meaning of gross domestic product (GDP) and potential impacts of changes of the rate of growth of GDP are explored. This Focus on Economic Data will also raise the question about a potential recession in the United States in 2008.

The Bureau of Economic Analysis (BEA) Announcement: February 28, 2008

'Real gross domestic product - the output of goods and services produced by labor and property located in the United States - increased at an annual rate of 0.6 percent in the fourth quarter of 2007, according to preliminary estimates released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 4.9 percent.

The GDP estimates released today (February 28) are based on more complete source data than were available for the advance estimates issued last month. In the advance estimates, the increase in real GDP was also 0.6 percent.

The increase in real GDP in the fourth quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, nonresidential structures, state and local government spending, and equipment and software that were largely offset by negative contributions from private inventory investment and residential fixed investment. Imports, which are a subtraction in the
calculation of GDP, decreased.

The deceleration in real GDP growth in the fourth quarter primarily reflected a downturn in inventory investment and decelerations in exports, in PCE, and in federal government spending that
were partly offset by a downturn in imports.'

[Note to teacher: The preliminary estimate of the fourth-quarter increase in real GDP is the same as the advance estimate issued in January, primarily reflecting a downward revision to imports that was largely offset by a downward revision to private inventory investment.]

Changes from the preceding month (advance) report:

Advance Report Preliminary Report Change
  January 30, 2008 February 28, 2008
Real GDP 0.6 0.6
Current-dollar GDP 3.2 3.3
Gross domestic purchases price    

[Note to teacher: The 0.1 percent increase in current dollar GDP and the increase of 0.1 percent in the price index offset each other and result in none change in real GDP.]

MATERIALS


Key Economic Indicators

as of February 20, 2009

Inflation

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.4 percent in January, before seasonal adjustment. The January level of 211.143 was virtually unchanged from January 2008.

Employment and Unemployment

Nonfarm payroll employment decreased by 598,000 in January and the unemployment rate rose from 7.2 to 7.6 percent.

Real GDP

Real gross domestic product decreased at an annual rate of 3.8 percent in the fourth quarter of 2008. In the third quarter, real GDP decreased 0.5 percent.

Federal Reserve

At its January 28, 2009 meeting, the Federal Open Market Committee decided to keep its target range for the federal funds rate at 0 to 1/4 percent.

PROCESS

Goals of GDP Focus on Economic Data

The goals of the GDP Focus on Economic Data are to provide teachers and students:

  • Access to easily understood, timely interpretations of monthly announcements of rates of change in real GDP and the accompanying related data in the U.S. economy
  • Descriptions of major issues surrounding the data announcements
  • Brief analyses of historical perspectives
  • Questions and activities to use to reinforce and develop understanding of relevant concepts
  • A list of publications and resources that may benefit classroom teachers and students interested in exploring inflation.

[Note to Teacher: Material that appears in italics is included in the teacher version only. All other material appears in the student version. Throughout the semester, the GDP cases will become progressively more comprehensive and advanced.]

Original U.S. Bureau of Economic Analysis Announcement and Data: www.bea.gov/bea/newsrel/gdpnewsrelease.htm

The Bureau of Economic Analysis (BEA) Announcement: February 28, 2008


'Real gross domestic product - the output of goods and services produced by labor and property located in the United States - increased at an annual rate of 0.6 percent in the fourth quarter of 2007, according to preliminary estimates released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 4.9 percent.

The GDP estimates released today (February 28) are based on more complete source data than were available for the advance estimates issued last month. In the advance estimates, the increase in real GDP was also 0.6 percent.

The increase in real GDP in the fourth quarter primarily reflected positive contributions from personal consumption expenditures (PCE), exports, nonresidential structures, state and local government spending, and equipment and software that were largely offset by negative contributions from private inventory investment and residential fixed investment. Imports, which are a subtraction in the
calculation of GDP, decreased.

The deceleration in real GDP growth in the fourth quarter primarily reflected a downturn in inventory investment and decelerations in exports, in PCE, and in federal government spending that were partly offset by a downturn in imports.'

[Note to teacher: The preliminary estimate of the fourth-quarter increase in real GDP is the same as the advance estimate issued in January, primarily reflecting a downward revision to imports that was largely offset by a downward revision to private inventory investment.]

2007 Real Gross Domestic Product Growth

The BEA also announced the change in GDP for the full year of 2007.

'Real GDP increased 2.2 percent in 2007 (that is, from the 2006 annual level to the 2007 annual level), compared with an increase of 2.9 percent in 2006.

The major contributors to the increase in real GDP in 2007 were personal consumption expenditures (PCE), exports, nonresidential structures, and state and local government spending. These positive contributions were partly offset by decreases in residential fixed investment and in inventory investment. Imports, which are a subtraction in the calculation of GDP, increased.

The deceleration in real GDP primarily reflected a larger decrease in residential fixed investment, a downturn in private inventory investment, and a deceleration in equipment and software that were
partly offset by a deceleration in imports.

The price index for gross domestic purchases increased 2.7 percent in 2007, compared with an increase of 3.3 percent in 2006.

Current-dollar GDP increased 4.9 percent, or $649.1 billion, in 2007. Current-dollar GDP increased 6.1 percent, or $760.8 billion, in 2006.

During 2007 (that is, measured from the fourth quarter of 2006 to the fourth quarter of 2007), real GDP increased 2.5 percent. Real GDP increased 2.6 percent during 2006. The price index for gross domestic purchases increased 3.3 percent during 2007, compared with an increase of 2.4 percent during 2006.'

[Note to teacher: The BEA actually announces GDP in a series of announcements. Each of the four steps includes further revision as new data are used to evaluate the initial numbers. The BEA defines these announcements in this way.]


'Advance' estimates are based on source data that are incomplete or subject to further revision by the source agency, are released near the end of the first month after the end of the quarter. These are the numbers released January 30, 2008.

As more detailed and more comprehensive data become As more detailed and more comprehensive data become available, the 'preliminary' and 'final' estimates are released, near the end of the second and third months, respectively. These are more reliable, as they have been computed with better data. The preliminary data were released February 29, 2008, and are the subject of this Focus on Economic Data.

The 'latest' estimates reflect the results of both annual and comprehensive revisions. Over time, these numbers reveal a more accurate pattern of GDP growth.

Real GDP Growth - Quarterly and Annual Rates

Rates of change in GDP figures are reported for years and quarters. When the quarterly rates of increase are reported, they are reported as though the changes at occurred for an entire year (annual rate). If the rate of growth during the first quarter of the year had continued for an entire year, real GDP would have been seven-tenths of one percent higher. (The actual growth rate during the quarter was approximately one-fourth of .7 percent or slightly over .17 of one percent.) This means that for all practical purposes, there was practically no growth in real GDP in the quarter.

Reporting at annual rates makes it easier to compare the change in one quarter to the change of another quarter and to the rate of change over the entire year.

The February 28, 2008, report indicates a slight increase of .1 percent in current dollar (nominal) GDP, but also a slight increase of .1 percent in the GDP price index (inflation). The net result is no change in the real rate of GDP growth.

Definition of Gross Domestic Product

Gross Domestic Product (GDP) is one of the most commonly reported measurements of economic activity. It is the total value 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.

Determining Real Gross Domestic Product

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.

There are often a number of different measures of GDP reported. Nominal GDP, or simply GDP, is total output in current prices. Real GDP is total output with prices held constant.

Real GDP per capita is the real GDP per person in the economy and is the best measure of well-being of all the other measures. One approximate means of calculating real GDP per capita is to identify the increase in nominal GDP and then subtract the percentage increase in prices and the percentage increase in population. That would leave the percentage increase in real GDP per capita.

GDP Data Trends

Following the 2001 recession, growth in real GDP increased by 1.6 percent in 2002, 2.5 percent in 2003, and 3.6 percent in 2004. The annual rate of growth decreased slightly to 3.1 percent in 2005 and 2.9 percent in 2006. Growth in the first quarter of 2007 was very slow, but increased over the next two quarters to 3.8 and 4.9 percent. The 0.6 percent rate of growth in the fourth quarter of 2007 is the lowest since the fourth quarter of 2002.

The reports of the rates of growth over the last twelve months have been erratic, from slightly less than one percent in the first-quarter to 4.9 percent in the third quarter. 2007 ended with the slowest growth of any twelve-month period since 2002-2003. Figure 1 and Table 1 illustrate recent changes in US real GDP growth.

What sectors of the economy are growing?

According to the February 28, 2008, BEA report:


'The major contributors to the increase in real GDP in 2007 were personal consumption expenditures (PCE), exports, nonresidential structures, and state and local government spending. These positive contributions were partly offset by decreases in residential fixed investment and in inventory investment. Imports, which are a subtraction in the calculation of GDP, increased.

The deceleration in real GDP primarily reflected a larger decrease in residential fixed investment, a downturn in private inventory investment, and a deceleration in equipment and software that were partly offset by a deceleration in imports.'

Real GDP Per Capita (per person)

The meaning of GDP may be more meaningful when expressed relative to nation's population, called Real Per Capita GDP. Real per capita GDP (adjusted for purchasing power) is a common way to compare our 'standard of living' to that of other nations.

The chart below shows the nominal and real per capital GDP's of the United States, the European Union, Japan and China. Notice the relationship of nominal GDP to per capital GDP. China, for instance has a large GDP compared to other developing nations. But, when China's GDP is expressed 'per capita,' it is much smaller than many nations. While China's nominal GDP growth is increasing relative to the U.S., it's real per capita GDP as a measure of standard of living may not be as significant.

Nominal GDP- Selected Nations (Reported by the World Bank, 2006)

Nation Nation/Economy Nominal GDP (millions) Nation/Economy Nominal GDP Real per capita (millions)
United States $13,201.80 $44,970
European Union $10,526.50 $34,149
Japan $4,340.10 $38,410
China $2,668.10 $2,010
World total $48,244.90 $7,439

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 policies, our investment and saving patterns, the quality of our technological advances, and our material well-being. Changes in real GDP per capita provide our best measures of changes in our material standards of living.

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. This current increase in real GDP will be discussed in news reports as a positive sign of the strength of the current economy.

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 decreases in real GDP as indicators of recessions. A popular definition of a recession is at least two consecutive quarters of declining real GDP.

Long-term Trends

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 of the 1990s being at or over 4.1 percent per year. Growth slowed in the beginning of the 2000s, but rebounded and averaged 3.5 percent on an annual basis for the 2003 through 2006 period. The rate of growth declined in 2007.

The upward trend in economic growth over the past decade has been accompanied by increases in the rates of growth of consumption spending, investment spending, and exports. Productivity increases, expansions in the labor force, decreases in unemployment, and increases in the amount of capital have allowed real GDP to grow at the faster rates. Figure 2 shows the history of growth since the 1970s. Figure 2 also shows the average annual rate of growth of 3.1 percent since 1970.

The longer run rate of growth of 3.1 percent has most recently been caused by a one percent increase in the number of people working and about a two percent increase in productivity of each worker. During the periods prior to the 1990s, the productivity increase contribution was slightly less than two percent and the labor force growth part slightly higher than one percent.

Prices


The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 3.9 percent (preliminary) in the fourth quarter, compared with an increase of 1.8 percent in the third. Excluding food and energy prices, the price index for gross domestic purchases increased 2.5 percent in the fourth quarter, compared with an increase of 1.9 percent in the third. It increased at an average annual rate of 2.9 percent for all of 2004, 2005, and 2006. See the latest inflation focus on economic data for a discussion of the recent increases in price levels.

The Federal Open Market Committee pays particular attention to the portion of the GDP index that focuses on consumption purchases and in particular that index that excludes purchases of energy and food items. This is an effort to use a broader index than just the core CPI. The FOMC believes that this index also more accurately reflects trends in prices. See the latest FOMC focus on economic data for more information.

Details of the Fourth-Quarter Changes in Real GDP

'The major contributors to the increase in real GDP in 2007 were personal consumption expenditures (PCE), exports, nonresidential structures, and state and local government spending. These positive contributions were partly offset by decreases in residential fixed investment and in inventory investment. Imports, which are a subtraction in the calculation of GDP, increased.

The deceleration in real GDP primarily reflected a larger decrease in residential fixed investment, a downturn in private inventory investment, and a deceleration in equipment and software that were
partly offset by a deceleration in imports.'

Highlights by Category (BEA Report, February 28, 2008)

  • Consumers- 'Real personal consumption expenditures increased 1.9 percent in the fourth quarter, compared with an increase of 2.8 percent in the third. Real nonresidential fixed investment increased 6.9 percent, compared with an increase of 9.3 percent.'
  • Investment- 'Nonresidential structures increased 14.7 percent, compared with an increase of 16.4 percent. Equipment and software increased 3.3 percent, compared with an increase of 6.2 percent. Real residential fixed investment decreased 25.2 percent, compared with a decrease of 20.5 percent.'
  • Trade- 'Real exports of goods and services increased 4.8 percent in the fourth quarter, compared with an increase of 19.1 percent in the third. Real imports of goods and services decreased 1.9 percent, in contrast to an increase of 4.4 percent.'
  • Government- 'Real federal government consumption expenditures and gross investment increased 0.9 percent in the fourth quarter, compared with an increase of 7.1 percent in the third. National defense decreased 0.3 percent, in contrast to an increase of 10.1 percent. Nondefense increased 3.4 percent, compared with an increase of 1.1 percent. Real state and local government consumption expenditures and gross investment increased 3.0 percent, compared with an increase of 1.9 percent.'

The Role of Productivity

A major factor in the long-term growth in the American economy is continued improvement in productivity. In the fourth quarter of 2007, productivity increased 0.6 percent in the business sector, with output increasing 0.2 percent and hours decreasing 0.5 percent. Business sector productivity grew at an annual rate of 6.7 percent during the third quarter of 2007, the largest gain since a 9.1 percent increase in the third quarter of 2003 (seasonally adjusted annual rates).

With productivity increases, businesses are able to gain more output from the same number of workers. But businesses also need more workers. If real GDP grows faster than the increase in productivity, more workers are needed to produce the real GDP and employment will rise in the quarter. If output rises more slowly than the rise in productivity, than fewer workers or fewer hours of work will be needed to produce the real GDP.

The Federal Reserve has stated in many of its recent releases that continued productivity growth is a key component in the continued growth in the American economy. Businesses are able to expand production more rapidly than the growth in employment and thus, the most important consequence, real GDP per capita can increase.

Is the U.S. Headed for a Recession?

Slowing growth in the United States has caused many economists and business leaders to predict that the U.S. will enter a recession soon. Some think that we are already in one.

The National Bureau of Economic Research (NBER) 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.' Generally this means that a period of two consecutive quarters of negative growth will be identified as a recession.

The current data show a decline in employment, but not as large as in the previous recession. Real income growth slowed but did not decline. Manufacturing and trade sales and industrial production both declined and had been doing so for some time.

Recent U.S. Recessions


On November 2001, the National Bureau of Economic Research announced though its Business Cycle Dating Committee that it had determined that a peak in business activity occurred in March of 2001. That signaled the official beginning of a recession. In July 2003, the committee reported its determination of the end of the recession as of November 2001.

The previous 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. 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 rapidly even after it came out a period of falling output and income.

The full press release on recessions from the National Bureau of Economic Research see: www.nber.org/cycles/cyclesmain.html

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.

Explanations of GDP and its Components

Gross domestic product consists of goods and services produced for consumption, for investment, for government, and for export. The GDP accounts are broken down into consumption spending, investment spending, government spending, and spending on U.S. exports. To arrive at the amount actually produced (that is, GDP) our spending on imports is subtracted from those other amounts of spending. Thus,

GDP = Consumption spending + investment spending + government spending + export spending – import spending

Consumption spending consists of consumer spending on goods and services. It is often divided into spending on durable goods, non-durable goods, and services. These purchases currently account for 70 percent of GDP.

  • Durable goods are items such as cars, furniture, and appliances, which are used for several years.
  • Non-durable goods are items such as food, clothing, and disposable products, which are used for only a short time period.
  • 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.
  • Investment spending 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.
  • Residential investment is the building of a new homes or apartments.
  • Inventory changes consist of changes in the level of stocks of goods necessary for production and finished goods ready to be sold.
  • Government spending 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 (19 percent) does not include transfer payments such as Social Security, unemployment compensation, and welfare payments, which do not represent production of goods and services. Federal defense spending now accounts for approximately 5 percent of GDP. State and local spending on goods and services accounts for 12 percent of GDP, while federal spending is 7 percent of GDP.
  • Exports are goods and services produced in the U.S. and purchased by foreigners – currently about 11 percent of GDP.
  • Imports are items produced by foreigners and purchased by U.S. consumers are equal to about 17 percent of GDP. Net exports (exports minus imports) are negative and are about 6 percent of the GDP.

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 real GDP; the second announcement or revision is described as the preliminary announcement; and the third month (this one) is the final revision. While labeled as the final version, even it will eventually be revised after the final data for the year are published. From 1983 to 2002, the advance estimates of the rate of growth in real GDP have been revised an average of 0.5 percent in the next month's preliminary estimate. The preliminary estimates have been revised by an average of an additional 0.3 percent.

Revisions in inventory investment and the international trade data are often the causes of changes in the GDP figures. Those data for the last month of the quarter are not available when the advance estimate of GDP is announced and only initial estimates are available at the time of the preliminary estimate. In the current quarter, the revision was primarily due to larger increases in exports.

Full Employment Real GDP


Economists define the approximate unemployment rate, at which there are not upward or downward pressures on wages and price, as full employment rate of unemployment. If unemployment falls to level below the full employment rate, there will be upward pressure on wages and prices. If unemployment rises to a very high rate, there will downward pressure on wages and prices or wages and prices will remain steady. In the middle is a level, or more likely a range, where there is not pressure on wages and prices to rise or fall.

The level of real GDP that can be produced at that rate of unemployment is described at the full employment level of real GDP. Sometimes it is described as the potential level of real GDP. It is the highest level that an economy can produce at any given time without causing significant inflation.

How can we increase economic growth over time?

Economic growth is a function of the technological innovation and the amount and quality of labor and capital in the economy:

As more people are employed, the amount of capital increases, education levels increase, the quality of capital changes, or the technology increases, the productive capacity of the economy increases. Therefore, the economy can increase its output giving consumers more disposable income, promoting an increase in consumption spending, and providing resources for business to use for further investment and government to use to provide public goods and services.

Increased labor force participation increases output. Expanded, improved education creates more productive workers. Business and government spending on research and development enhance our abilities to produce and allow each worker to become more productive, increasing incomes for all.

Finally, to achieve a higher level of GDP in the future, consumers need to limit consumption spending and increase savings today, permitting businesses to invest more in capital goods. If resources are invested into building an economy now, future generations will enjoy a higher level of economic growth; our businesses will produce more goods and consumers can purchase more goods. Expansion of output at rates faster than our population growth is what gives us the opportunity to enjoy higher standards of living.

Economic Policy Options


There are two type of policies government can use to stimulate the economy (or slow it down). Policy actions to stimulate growth are referred to a 'expansionary' policies. Policy actions to slow the economy are referred to a 'contractionary' policies.

Monetary Policies


Monetary policies are those that influence the supply of money or interest rates in the economy. These policies are tools of the Federal Reserve System. The Federal Reserve determines policies through the Federal Open Marker Committee (FOMC). The FOMC consists of twelve members--the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis.

The FOMC holds eight regularly scheduled meetings per year. At these meetings, the Committee reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth.

  • Open Market Operations- the buying or selling of government securities in the 'open market.'
  • Discount Rate- the interest rate charged by the Federal Reserve Banks to member banks.
  • Reserve Requirements- The percentage of deposits banks must keep on reserve in their vaults or in accounts in the federal Reserve Banks. A banks ability to make loans is increases when it has more excess reserves.

A Note on the Federal Funds Rate

In the news, you will read that the Federal Reserve has set a target for the federal funds rate or desired quantity of reserves.

Using its monetary policy tools, the Federal Reserve can influence the demand and supply of balances that depository institutions hold at Federal Reserve Banks. This will alter the federal funds rate. The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.

Changes in the federal funds rate affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output, and prices of goods and services.

Fiscal Policies

Fiscal policies are the use of government revenues (spending or taxes) to expand or contract the economy.

  • Spending- The Federal government can increase spending to stimulate the economy or decrease spending to slow it down.
  • Taxes- The federal government can increase taxes to slow the economy or decrease taxes to stimulate the economy.

In a time when the economy is slow, the Federal Reserve can:

  • Buy securities to expand the money supply
  • Lower the discount rate to increase banks' excess reserves
  • Decrease reserve requirements to increase banks' excess reserves

The federal government can:

  • Spend more money to increase aggregate demand and create jobs
  • Lower taxes to leave more money in the hands of people or businesses to spend

Stagflation

In response to the Real GDP announcement and recent increases in the price level, Ethan S. Harris, chief Unites States economist for Lehman Brothers said, 'the one word description of this report is 'stagflation,' in a New York Times interview. Stagflation refers to a time when there is inflation and unemployment in the economy at the same time.

In the past, the theory was that inflation and unemployment would not happen at the same time - the so-called 'Phillips Curve' concept first identified by economist Alban Phillips. The idea was that increased unemployment would abate inflationary pressures and that policies to reduce one would tend to increase the other. This theory was largely abandoned in the 1970s when we experienced both inflation and unemployment at the same time and the term stagflation was coined by United Kingdom Chancellor of the Exchequer Iain MacLeod in 1965. In the 1990s, the United States experienced very low inflation and very low unemployment at the same time.

Stagflation creates conflict for many policy makers who fear that anti-inflationary policies will increase unemployment and that expansionary policies monetary ands fiscal policies might contribute to inflation.

ASSESSMENT ACTIVITY

Have the students click the start button below to test their knowledge on thjs GDP lesson.

Have the students discuss this prompt:

 

U.S. real gross domestic product growth is slowing and employment growth is slowing.

  1. What policy options are available to the government to increase output and employment? [The student answers should: 1. Identify monetary policies that are intended to stimulate the economy, such as selling government securities, reducing the discount rate and/or reducing bank reserve requirements. 2. Identify fiscal policies that are intended to stimulate the economy, such as tax cuts or rebates, and increased government spending. 3. Identify the intended impact of these policy as an increase in employment, spending and/or investment.]  

The rate of growth of U.S. real GDP is slowing. Output is increasing very slowly and unemployment has increased in recent months. What does this mean to you?

[1. Students should be able to identify the relationship between slower growth and higher unemployment trends.

2. Students should be able to explain how these trends impact the number of opportunities for employment for themselves and others.]

Have students write one or two paragraphs on this prompt:

CONCLUSION

Summary:

  • U.S. Real gross domestic product increased at an annual rate of 0.6 percent in the fourth quarter of 2007, according to preliminary estimates released by the Bureau of Economic Analysis.
  • For the year 2007, Real GDP increased 2.2 percent from the 2006 annual level, compared with an increase of 2.9 percent in 2006.
  • The rate of growth of the U.S. economy has been slowing over the last few years. If GDP growth stops or declines of at least six months, the U.S. may enter a recession.
  • Time will tell if recent Federal Reserve FOMC actions to reduce the target fed funds rate and tax rebates to pump more funds into the economy will stimulate growth.
  • Also remember that the Federal Reserve's primary policy target has recently been inflation. Any inflationary pressure that results from expansionary policies may have to be dealt with later.

EXTENSION ACTIVITY

Read the most recent report by the U.S. Bureau of Labor Statistics on 'Productivity and Costs.' The report can be accessed through the BLS web site at www.bls.gov/news.release/prod2.nr0.htm .

The Productivity and Costs report is issued during the first week of each month, in a series of advanced, preliminary, revised, and annual average reports, similar to the series of GDP reports.

  1. Have students read the Productivity and Costs report.
  2. Identify the measurements that determine productivity.

    [BLS definition: 'Productivity is measured by comparing the amount of goods and services produced with the inputs which were used in production. Labor productivity is the ratio of the output of goods and services to the labor hours devoted to the production of that output. Unit labor costs are calculated by dividing total labor compensation by real output or - equivalently - by dividing hourly compensation by productivity.]

  3. Discuss: What factors have influenced the recent improvements in productivity in the U.S. economy?

    [BLS: 'Labor is an easily-identified input to virtually every production process. In the U.S. non farm business sector, labor cost represents more than sixty percent of the value of output produced.'

    Productivity is a function of the efficiency of labor and the impact of capital investment. Multi factor productivity measures output per unit of labor and capital, and, in some cases, the costs of intermediate inputs such as fuel.

    In the end, productivity is determined by the costs of production (primarily labor) and the value of output.]