This lesson focuses on the March 27, 2008, 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 questions the impact of the current level of growth on the economy and individuals.

KEY CONCEPTS

Business, Business Cycles, Economic Growth, Macroeconomic Indicators, Tools of the Federal Reserve

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 March 27, 2008, final 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 questions about the potential for a recession in the United States in 2008.

MATERIALS


Key Economic Indicators

as of March 27, 2008

Inflation

The Consumer Price Index for All Urban Consumers (CPI-U) increased 0.3 percent in February before seasonal adjustment. The February level of 211.693 was 4.0 percent higher than in February 2007.

Employment and Unemployment

The U.S. Unemployment Rate was 4.8% in February 2008, a decrease of 0.1% from January 2008. There were a total of 7.4 million unemployed people in February, 2008.

Real GDP

Real GDP Growth increased at a .6% annual rate in the 4th quarter of 2007.

Federal Reserve

The Federal Reserve FOMC lowered the target federal funds rate by .75% to 2.5%.

PROCESS

U.S. Department of Commerce: Bureau of Economic Analysis: March 27, 2008

The announcement:

'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 final estimates released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 4.9 percent.

The GDP estimates released today are based on more complete source data than were available for the preliminary estimates issued last month. In the preliminary 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 federal government spending, and in PCE that were partly offset by a downturn in imports.

Final sales of computers contributed 0.16 percentage point to the fourth-quarter growth in real GDP after contributing 0.28 percentage point to the third-quarter growth. Motor vehicle output subtracted 0.86 percentage point from the fourth-quarter growth in real GDP after contributing 0.36 percentage point to the third-quarter growth.'

Gross National Product (GNP)


'Real gross national product, the goods and services produced by the labor and property supplied by U.S. residents, increased 1.9 percent in the fourth quarter, compared with an increase of 5.8 percent in the third.'

Gross Domestic Product (GDP)


'GNP includes, and GDP excludes, net receipts of income from the rest of the world, which increased $37.6 billion in the fourth quarter after increasing $25.9 billion in the third. In the fourth quarter, receipts decreased $12.9 billion, and payments decreased $50.5 billion.'

GNP vs. GDP


GNP measures the total value of goods and services produced by workers from a country regardless of where they produce them. GNP includes such items as corporate profits that multinational firms earn in overseas markets. If an American firm operates a plant in Mexico, the firm's profits are included in the U.S. GNP.

In comparison, GDP measures the total amount of goods and services that are produced within a country's borders. The production of the American company's plant in Mexico is included in Mexico's GDP.

Current-dollar GDP


'Current-dollar GDP, the market value of the nation's output of goods and services, increased 3.0 percent, or $103.7 billion, in the fourth quarter to a level of $14,074.2 billion. In the third quarter, current-dollar GDP increased 6.0 percent, or $201.7 billion.'

The Bureau of Economic Analysis publishes an online guide to 'Measuring the Economy: A Primer on GDP and the National Income and Product Accounts: www.bea.gov/national/pdf/nipa_primer.pdf .

The BEA guide provides a rationale for measuring GDP and other national income and products accounts (NIPAs) data and it's use for policy makers. The introduction explains...

'How fast is the economy growing? Is it speeding up or slowing down? How does the trade deficit affect economic growth? What’s happening to the pattern of spending on goods and services in the economy?

To answer these types of questions about the economy, economists and policymakers turn to the national income and product accounts (NIPAs) produced by the Bureau of Economic Analysis (BEA). The NIPAs are a set of economic accounts that provide information on the value and composition of output produced in the United States during a given period and on the distribution and uses of the income generated by that production. Featured in the NIPAs is gross domestic product (GDP), which measures the value of the goods and services produced by the U.S. economy in a given time period.

GDP is one of the most comprehensive and closely watched economic statistics: It is used by the White House and Congress to prepare the Federal budget, by the Federal Reserve to formulate monetary policy, by Wall Street as an indicator of economic activity, and by the business community to prepare forecasts of economic performance that provide the basis for production, investment, and employment planning.

But to fully understand an economy’s performance, one must ask not only “What is GDP?” (or “What is the value of the economy’s output?”), but other questions such as: “How much of the increase in GDP is the result of inflation and how much is an increase in real output?” “Who is producing the output of the economy?” “What output are they producing?” “What income is generated as a result of that production?” and “How is that income used (to consume more output, to invest, or to save for future consumption or investment)?”

What happened to the measurement of real GDP during the 4th Quarter of 2007?

The March 27, 2008, BEA announcement referred to the 'final' estimate of real GDP. GDP data is released three times (monthly) following each quarter. For this reporting period, the first month's release (January) was the 'advance' estimate. The second month's release (February) was the 'preliminary' estimate. The third month's release (March 27) is the 'final' estimate.

The BEA comment on revisions was 'the final estimate of the fourth-quarter increase in real GDP is the same as the preliminary estimate issued last month, primarily reflecting a downward revision to inventory investment and smaller downward revisions to several other GDP components that were largely offset by upward revisions to personal consumption expenditures and to exports.'

Revisions: Advance Preliminary Final

  Q1 Q2 Q3
Real DP* .6 .6 .6
Current-dollar GDP* 3.2 3.3 3.0
Gross domestic purchases
price index*
3.8 3.9 3.7
*Percent change from the previous quarter.

A More Detailed 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.

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.

The components used to determine GDP include:

  • Personal Consumption (C): Durable and nondurable goods, services.
  • Investment Spending (I): Nonresidential, residential, and business inventories
  • Government Expenditures (G): Defense, highways, schools, etc.
  • Net Exports (X): Exports are added to GDP. Imports are subtracted from GDP
  • Formula: GDP = C + I + G + X
  • (Consumption + Investment + Government Expenditures + Net Exports)

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. China, for instance has a large GDP compared to most nations. But, when China's GDP is expressed 'per capita,' it is much smaller than many nations.

Nominal GDP Rank Per Capita GDP Rank (2006)(millions)

U.S. $13,194,700 $45,594
China $2,644,692 $2,460,104
*The European Union is 1st with a GDP of $14,609,863 (millions)

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 illustrates recent changes in US real GDP growth.

figure1

What sectors of the economy are growing?

According to the March 27, 2008, BEA report:

'Real personal consumption expenditures increased 2.3 percent in the fourth quarter, compared with an increase of 2.8 percent in the third. Real nonresidential fixed investment increased 6.0 percent, compared with an increase of 9.3 percent. Nonresidential structures increased 12.4 percent, compared with an increase of 16.4 percent. Equipment and software increased 3.1 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.

Real exports of goods and services increased 6.5 percent in the fourth quarter, compared with an increase of 19.1 percent in the third. Real imports of goods and services decreased 1.4 percent, in contrast to an increase of 4.4 percent.

Real federal government consumption expenditures and gross investment increased 0.5 percent in the fourth quarter, compared with an increase of 7.1 percent in the third. National defense decreased 0.5 percent, in contrast to an increase of 10.1 percent. Nondefense increased 2.8 percent, compared with an increase of 1.1 percent. Real state and local government consumption expenditures and gross investment increased 2.8 percent, compared with an increase of 1.9 percent.

The real change in private inventories subtracted 1.79 percentage points from the fourth-quarter change in real GDP, after adding 0.89 percentage point to the third-quarter change. Private businesses decreased inventories $18.3 billion in the fourth quarter, following increases of $30.6 billion in the third quarter and $5.8 billion in the second.'

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.

GDP
(Reported by the World Bank, 2006)

Selected Nations Nominal GDP Nation Nominal GDP nominal GDP 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.

figure2

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.

A Recession in 2008?

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.

The National Bureau of Economic Research Business Cycle Dating Committee determines and reports on U.S. business cycles. The NBER identifies the dates of peaks and troughs that identify economic recessions or expansions.

The NBER defines a recession as 'a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.'

To identify trends, the NBER committee looks closely at two monthly measures of economic activity:

  • Personal income less transfer payments, in real term, employment.

In addition, the committee looks at two indicators of manufacturing and goods:

  • Industrial production, the volume of sales of the manufacturing and wholesale-retail sectors adjusted for price changes.

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.

To achieve a higher level of GDP in the future, consumers should limit consumption spending and increase savings, 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.

What Can be done?

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

* This is the intent of the tax rebate passed by Congress in early 2008

Stagflation

In response to the Real GDP data 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

Discussion Questions:

  1. If gross domestic product increases by three percent from one year to the next, are the country's citizens better off? Why or why not? [It is not clear whether or not they are better off. The answer depends upon what is happening to prices and what is happening to population growth. If prices and population together are rising by more than three percent per year, than they are, on average, worse off. They have fewer goods and services per person. An example would be if they were experiencing three percent inflation and a one percent growth in population, real GDP per capita would have fallen over the year by one percent.]
     
  2. Why is income not included in gross domestic product? [Gross domestic product includes all of the production of final goods and services in a year. Production of consumption, investment, government, and export goods and services are included. Income is not added to the total amounts of production when calculating GDP. However, wages, salaries, dividends, profits, and rents are part of the costs on producing those goods and services and are thus indirectly included. An alternative way of calculating GDP is to add all of the income payments together.]
     
  3. If GDP increased by 5 percent and real GDP increased by 5 percent, what has happened to the average price level? [If nominal (current dollar) GDP increased by 5 percent and the amount of output increased by 5 percent, then prices must not have changed.]

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 final estimate 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

Go to the BEA News Release: Gross Domestic Product (GDP) by State, 2006 (released June 7, 2007)
www.bea.gov/newsreleases/regional/gdp_state/gsp_newsrelease.htm

The U.S. growth in real GDP by state was faster in 2006 than the 1997-2005 average annual rate. Six of the eight BEA regions experienced faster growth.

Compare the growth of GDP in your state to neighboring states?

  • Did your state do better or worse than neighboring states?
  • Did your region do better or worse than other regions?
  • How do you think your state and region has done since these data were released?