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INTRODUCTION

This lesson focuses on the BEA's first (advance) estimate of real GDP released on October 26, 2012, for the third quarter  of 2012 (July-September.) Understanding the level and rate of growth of the economy's output (GDP) helps to better understand growth, employment trends, the health of the business sector, and consumer well-being. 

Each Real GDP lesson will provide the most up-to-date data and focus on some specific topics or issues related to GDP:

  • August (second estimate for Q2 2012): How to read the data, real vs. nominal, and how the data is collected.
  • September (third estimate for Q2 2012): Factors influencing the change in GDP, revisions, and seasonal adjustment.  
  • October (first estimate for Q3 2012): Business cycles and indicators of future growth or decline.  THIS LESSON
  • November (second estimate for Q3 2012): Regional GDP growth data and international comparisons.
  • December (third estimate for Q3 2012): Year End Summary.

TASK

  • 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.
  • Assess the relationship of real GDP data, the indexes of economic indicators, and business cycles.
  • Speculate about the nature and impact of current economic conditions and implications for the future.

PROCESS

The Bureau of Economic Analysis' (BEA) first (advance) estimate of U.S. real GDP growth in the third quarter of 2012 was an increase of 2.0 percent.  This was a slight increase from the final estimate for Q2, but significantly below the historical average real GDP growth rate of 3.28 percent.

The U.S. economy has recently grown at a rate many observers consider to be less than necessary for the economy to sustain itself and not enough to really pull the United States out of the recent recession and to reduce the persistently high U.S. unemployment rate. 

Take a look at U.S. GDP real growth for the third quarter of 2011 and decide for yourself if it is enough to be called "good news."

Important Note:  Unless otherwise cited, quoted materials in this lesson are from the Bureau of Economic Analysis' October 26, 2012, first estimate of U.S. gross domestic product for the third quarter of 2012.

U.S. Bureau of Economic Analysis News Release:
Gross Domestic Product, Third Quarter 2012 (Advance Estimate)
Released October 26, 2012

"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 2.0 percent in the third quarter of 2012 (that is, from the second quarter to the third quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 1.3 percent."

Students: If you know the current and previous period GDP estimates, can you determine the percentage rate of increase in real GDP?

  1. Subtract the current real GDP level from the previous level.  13,616.2 (Q3) minus 13,548.5 (Q2) = 67.7.
  2. Divide the difference by the previous level (Q2). 67.7 divided by 13,548.5 = 0.004997.
  3. Multiply that percentage by 4 (4 quarters.)  0.004997 times 4 = 0.0199  or 1.99 percent. This is the simple method of reaching an approximate annualized rate.

The reported rate of real GDP growth was 2.0 percent.  The difference is due to BEA statistical methodology and/or rounding.

Remember, real GDP estimates for a quarter are released three times over three months. For the third quarter of 2012, the first estimate in October, 2012, was a 2.0 percent annualized growth rate. The second estimate will be made in November and the third estimate in December. 

The BEA explains, "The Bureau emphasized that the third-quarter advance estimate released today is based on source data that are incomplete or subject to further revision by the source agency (see box below). The "second" estimate for the third quarter, based on more complete data, will be released on November 29, 2012."

Students: Does it makes sense to revise and report GDP growth three times over three months following each quarter.  What kind of new information might result in a revision? 

The BEA commented on the increase or decrease in real GDP citing two measurements of change. When they use the term “acceleration,” they refer to the rate of change. The real GDP announcement also cites the “increase” or the dollar value increase in the various sectors. The two following paragraphs from the news release identify the sectors that contributed to the total increase or subtracted from the overall increase in two ways.

"The increase in real GDP in the third quarter primarily reflected positive contributions from personal consumption expenditures (PCE), federal government spending, and residential fixed investment that were partly offset by negative contributions from exports, nonresidential fixed investment, and private inventory investment. Imports, which are a subtraction in the calculation of GDP, decreased."

"The acceleration in real GDP in the third quarter primarily reflected an upturn in federal government spending, a downturn in imports, an acceleration in PCE, a smaller decrease in private inventory investment, an acceleration in residential fixed investment, and a smaller decrease in state and local government spending that were partly offset by downturns in exports and in nonresidential fixed investment."

Each month recently, the BEA has commented specifically on two important product groups – motor vehicles and computers. "Final sales of computers added 0.17 percentage point to the third-quarter change in real GDP after subtracting 0.10 percentage point from the second-quarter change. Motor vehicle output subtracted 0.47 percentage point from the third-quarter change in real GDP after adding 0.20 percentage point to the second-quarter change."

Students: Why do you think the BEA specifically reports on automobiles and computers in the announcement? How might automobiles (major long-term purchases) and computers (discretionary for consumers and investment for businesses) be good indicators of confidence and of future economic activity?

From quarter to quarter, real GDP growth rates can vary significantly.  Figure 1, below, shows the growth rates of U.S. real GDP from 2000 through Q3 2012. Note the business cycles – periods of growth and decline. Business cycles are defined later in this lesson.

figure 1

Students:  Can you identify the recent periods of recession from the graph? 

To confirm the "official" recessions identified by the National Bureau of Economic Research (NBER), go to: www.nber.org/cycles/cyclesmain.html ]

A Note About “Real” GDP Growth

To adjust for the effect of inflation and to determine “real” GDP, the BEA uses a price index. The price index for gross domestic purchases is the “percent change in the price index for gross domestic purchases. This index measures the prices of goods and services purchased by U.S. residents, regardless of where the goods and services are produced. The gross domestic purchases price index is derived from the prices of personal consumption expenditures, gross private domestic investment, and government consumption expenditures and gross investment. Thus, for example, an increase in the price of imported cars would raise the prices paid by U.S. residents and thereby directly raise the price index for gross domestic purchases.”

For Q3 2012, the BEA stated in the news release, "The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 1.5 percent in the third quarter, compared with an increase of 0.7 percent in the second. Excluding food and energy prices, the price index for gross domestic purchases increased 1.3 percent in the third quarter, compared with an increase of 1.4 percent in the second."

What sectors grew or declined in Q3 2012?

  • Real personal consumption expenditures increased 2.0 percent in the third quarter, compared with an increase of 1.5 percent in the second. Durable goods increased 8.5 percent, in contrast to a decrease of 0.2 percent. Nondurable goods increased 2.4 percent, compared with an increase of 0.6 percent. Services increased 0.8 percent, compared with an increase of 2.1 percent."
  • "Real nonresidential fixed investment decreased 1.3 percent in the third quarter, in contrast to an increase of 3.6 percent in the second. Nonresidential structures decreased 4.4 percent, in contrast to an increase of 0.6 percent. Equipment and software decreased less than 0.1 percent, in contrast to an increase of 4.8 percent. Real residential fixed investment increased 14.4 percent, compared with an increase of 8.5 percent."
  • "Real exports of goods and services decreased 1.6 percent in the third quarter, in contrast to an increase of 5.3 percent in the second. Real imports of goods and services decreased 0.2 percent, in contrast to an increase of 2.8 percent."
  • "Real federal government consumption expenditures and gross investment increased 9.6 percent in the third quarter, in contrast to a decrease of 0.2 percent in the second. National defense increased 13.0 percent, in contrast to a decrease of 0.2 percent. Nondefense increased 3.0 percent, in contrast to a decrease of 0.4 percent.
  • Real state and local government consumption expenditures and gross investment decreased 0.1 percent, compared with a decrease of 1.0 percent."
  • "The change in real private inventories subtracted 0.12 percentage point from the third-quarter change in real GDP after subtracting 0.46 percentage point from the second-quarter change. Farm inventories subtracted 0.42 percentage point from the third-quarter change after subtracting 0.17 percentage point from the second-quarter change. Nonfarm inventories added 0.30 percentage point to the third-quarter change after subtracting 0.29 percentage point from the second-quarter change."
     

Students:  Inventories are a subtraction for GDP.  Why and what does this might mean?

Students: How important is investment in future growth? 

A Reminder:

The formula for determining GDP is C+I+G+X = GDP

  • C = Personal consumption expenditures
  • I = Nonresidential fixed investment
  • G= Government expenditures
  • X= New exports (Exports minus imports)
     

Other Measures of U.S. Output

  • Gross domestic purchases - purchases by U.S. residents of goods and services wherever produced. "Real gross domestic purchases -- purchases by U.S. residents of goods and services wherever produced -- increased 2.1 percent in the third quarter, compared with an increase of 1.0 percent in the second."
     
  • Current-dollar GDP - the market value of the nation's output of goods and services.  Current dollar GDP "increased 5.0 percent, or $190.1 billion, in the third quarter to a level of $15,775.7 billion. In the second quarter, current-dollar GDP increased 2.8 percent, or $107.3 billion."

The "size" of the U.S. economy in today's dollars is almost $15.76 trillion (reported as $15,775.7 billion.)  That is approximately $50,136 real per capita GDP.  According to the U.S. Census Bureau, the resident population of the United States, projected in October, 2012, was approximately 314,665,000 people. "Per capita" means per person.

Students:  For a comparison of the U.S. per capita GDP to that of other nations, you can go to this World Bank web page.  http://search.worldbank.org/data?qterm=GDP%20per%20capita&language=EN .  Select one of the links on the page.

Figure 2, below, shows the current dollar and constant dollar GDP data from 2000 through Q3 2012. The difference between the current dollar figure and the constant dollar figure is the rate of inflation. These figures are in billions of U.S. dollars.  

figure 2

Students:  Be sure you understand the meanings of the “current dollar” and “constant dollar” measurements of GDP. You can relate this to the real purchasing power of income over time.

Business Cycles and Recessions

The BEA tracks changes in real GDP, the traditional measurement used to identify business cycles. Though it is a critical measure, real GDP is not the sole determinant in the identification of recessions. A recession, a "significant decline in economic activity spread across the economy, lasting more than a few months," is identified by the National Bureau of Economic Research (NBER) "Business Cycle Dating Committee." 

In addition to real GDP, the key measurements in the determination of a recession are real income, payroll employment, industrial production, and wholesale-retail sales. Recently, the NBER has identified payroll employment as the key criteria used to identify business cycles.

In its announcement of the beginning of the recession in December 2008, the NBER committee cited these trends in economic activity.  Payroll employment “reached a peak in December 2007 and has declined every month since then.

"Real personal income less transfer payments, real manufacturing and wholesale-retail trade sales, industrial production, and employment "all reached peaks between November 2007 and June 2008.”

In September, 2009, the NBER identified the end of the recession.  "The committee determined that a trough in business activity occurred in the U.S. economy in June 2009. The trough marks the end of the recession that began in December 2007 and the beginning of an expansion. The recession lasted 18 months, which makes it the longest of any recession since World War II. Previously the longest postwar recessions were those of 1973-75 and 1981-82, both of which lasted 16 months."

Business cycles are fluctuations in aggregate economic activity in cycles of expansion, peak, contraction, and trough. In a business cycle, several macroeconomics variables will move together (not lock-step in short periods) in a general trend. The cycles recur, but there is no consistent pattern of depth or length of time. The NBER will not identify a business cycle downturn as a recession unless it meets these general qualities and the declines are sufficient enough to meet the description as a "significant decline in economic activity spread across the economy, lasting more than a few months."

Figure 3, below, illustrates a "typical" business cycle, with periods of expansion, peak, decline and trough. 

figure 3

Measuring Economic Activities – Economic Indicators

Much attention is paid in the media to the "Index of Leading Indicators," a composite index used to estimate future economic activity. The Index is determined by The Conference Board, "a global independent membership organization working in the public interest. It publishes information and analysis, makes economics-based forecasts and assesses trends, and facilitates learning by creating dynamic communities of interest that bring together senior executives from around the world." 

The Index consists of a variety of measures of economic activity that have historically turned downward before contractions and upward before expansions. The Conference Board created a single index value, a "composite index," composed of ten variables. Many economists believe that the Index of Leading Indicators can "provide an early warning system so that policymakers can shift toward macroeconomic stimulus when the index fails."

The Conference Board's most recent report on Global Business Cycle Indicators ” was released on October 18, 2012.

The various cyclical indicators used by the Conference Board are classified into three categories—leading, coincident, and lagging, based on their timing in relation to the business cycle.

"The Conference Board Leading Economic Index® (LEI) for the U.S. increased 0.6 percent in September to 95.9 (2004 = 100), following a 0.4 percent decline in August, and a 0.4 percent increase in July."

Ataman Ozyildirim, economist at The Conference Board commented, “The U.S. LEI increased in September, more than offsetting the decline in August. The LEI has been signaling an economy that is fluctuating around a slow growth trend. The six-month growth rate has slowed substantially, but still remains in growth territory due to positive contributions from the housing and financial components. Meanwhile, the coincident economic index also increased in September.”

Ken Goldstein, economist at The Conference Board commented, “The single biggest challenge remains weak demand, domestically and globally. The struggle to regain firmer ground – in financial markets, international trade and global industrial output – continues because of weak consumer demand and a lack of more robust business investment.”

"The Conference Board Coincident Economic Index® (CEI) for the U.S. increased 0.2 percent in September to 105.1 (2004 = 100), following no change in August, and a 0.6 percent increase in July."

"The Conference Board Lagging Economic Index® (LAG) increased 0.1 percent in September to 116.8 (2004 = 100), following a 0.3 percent increase in August, and a 0.3 percent increase in July."

Coincident indicators, such as employment, production, personal income, and manufacturing and trade sales, measure current aggregate economic activity.

  • Employees on nonagricultural payrolls
  • Personal income less transfer payments
  • Index of industrial production
  • Manufacturing and trade sales
     

Leading indicators, such as average weekly hours, new orders, consumer expectations, housing permits, stock prices, and the interest rate spread, tend to change direction ahead of the business cycle

  • Average weekly hours, manufacturing
  • Average weekly initial claims for unemployment insurance
  • Manufacturers’ new orders, consumer goods and materials
  • Vendor performance, slower deliveries diffusion index
  • Manufacturers’ new orders, nondefense capital goods
  • Building permits, new private housing units
  • Stock prices, 500 common stocks 
  • Money supply, M2
  • Interest rate spread, 10-year Treasury bonds less Federal funds (%)
  • Index of consumer expectations
     

Lagging indicators tend to change direction after the coincident indicators. Lagging indicators represent costs of doing business, such as inventory-sales ratios, change in unit labor costs, average prime rate charged by banks, and commercial and industrial loans outstanding. Lagging indicators, such as the ratio of installment credit outstanding to personal income, the change in consumer prices for services, and average duration of unemployment reflect consumer behavior. The lagging indicators may confirm the trends identified with the leading and coincident indicators.

  • Average duration of unemployment
  • Inventories to sales ratio, manufacturing and trade
  • Change in labor cost per unit of output, manufacturing (%)
  • Average prime rate charged by banks (%)
  • Commercial and industrial loans outstanding
  • Consumer installment credit outstanding to personal income ratio
  • Change in consumer price index for services (%)
     

Students:  Do you know what these indicators mean? Go to the Conference Board web page: Economic Indicators for more information.]

CONCLUSION

Figure 4, below, shows the changes in the major components of U.S. gross domestic product from 2009 to Q3 2012, and the level of those components in Q3 2012.. Note that personal consumption expenditures are, by far, the largest component of GDP. Many analysts say that the true recovery from the recession will happen only when consumers increase their spending to previous levels. Others add that it will take increased business investment that results in job creation. 

figure 4

Recent government policy decisions to promote growth in the economy are aimed at stimulating one or more of the components - consumer spending, investment, government spending, or exports. The overall goal is to stimulate aggregate demand.

Aggregate demand can also be illustrated by the formula AD = C + I + G + (X-M):

  •     C = Consumers' expenditures on goods and services
  •      I = Investment spending by companies on capital goods
  •     G = Government expenditures on publicly provided goods and services
  •     X = Exports of goods and services
  •     M = Imports of goods and services
     

By direct government spending, creating jobs, promoting investment, and increasing output, employment is increased and income is created.  As those with new jobs earn income, they increase their spending - increasing aggregate demand.  The $787 billion federal stimulus (American Recovery and Reinvestment Act of 2009) was intended to do just that. The U.S. government’s www.Recovery.Gov web site reports that from Q3 2009 through Q3 2011, stimulus programs created 5,448,388 jobs.

ASSESSMENT ACTIVITY

EXTENSION ACTIVITY

Take another look at The Conference Board's  "Leading Economic Index" for the United States.

Which of these data points do you think are good indicators of the future health of the U.S. economy?

  • Average weekly hours, manufacturing
  • Average weekly initial claims for unemployment insurance
  • Manufacturers’ new orders, consumer goods and materials
  • Vendor performance, slower deliveries diffusion index
  • Manufacturers’ new orders, non-defense capital goods
  • Building permits, new private housing units
  • Stock prices, 500 common stocks
  • Money supply, M2
  • Interest rate spread, 10-year Treasury bonds less Federal funds (%)
  • Index of consumer expectations


Research one of these leading indicators. Summarize what it tells us about the future. For descriptions of the components of the Leading Economic Index, go to: www.conference-board.org/data/bci/index.cfm?id=2160 .

U.S. Indicators

Link to The Conference Board's most recent press release "Global Business Cycle Indicators"   http://www.conference-board.org/data/bcicountry.cfm?cid=1

Global Indicators

The Conference Board, "Global Economic Outlook, 2012,"http://www.conference-board.org/data/globaloutlook.cfm Global Business Cycle Indicators