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INTRODUCTION

Each month, the Bureau of Economic Analysis (BEA), an agency of the U.S. Department of Commerce, releases an estimate of the level and growth of U.S. gross domestic product (GDP), the output of goods and services produced by labor and property located in the United States.

This lesson focuses on the BEA's third (final) estimate of real GDP growth released on December 20, 2010, 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.

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

Growth of the U.S. economy picked up a little speed in the third quarter of 2012, according to the latest estimate of real GDP growth by the Bureau of Economic Analysis. While not at the rapid pace of the late 1990s or even at the level of the brief uptick in Q4 2011, the 3.1 percent real GDP growth in Q3 2012 is encouraging.

After hundreds of billions of dollars of economic stimulus spending and Federal Reserve quantitative easing (QE) policies to keep interest rates very low, the economy's output reached a level that economists look for to keep the economy on a recovery track.  Combined with the drop in unemployment in November to 7.7 percent, this news seems good.

Students: What level of growth do you consider to be good news?  What other data will show that the U.S. economy is really healthy?

Take a look at the most recent estimate of U.S. real GDP growth to better understand the pattern of growth in the economy and how the current conditions impact you and others.

U.S. Bureau of Economic Analysis
National Income and Product Accounts
Gross Domestic Product, 3rd quarter 2012 (third estimate)

Released December 20, 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 3.1 percent in the third quarter of 2012 (that is, from the second quarter to the third quarter), according to the "third" estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 1.3 percent."

NOTE: Unless otherwise cited, all quoted materials in this lesson are from the BEA, National Income and Product Accounts, Gross Domestic Product, 3rd quarter 2012 (third estimate) news release. December 20, 2012.

Over the past couple of years, real GDP growth has been erratic from quarter to quarter.  Look at Figure 1, below, to see the quarterly real GDP growth rates since the year 2000.  Note the period from early 2008 to mid-2009 - the most recent recession.

Figure 1

This final estimate of a 3.1 percent Q3 growth rate may be evidence of a more solid recovery.  Then again, the 4.1 percent growth rate reported in Q4 2011 raised the same question.  Are additional monetary or fiscal policy actions needed?   Will businesses and consumers be more optimistic when the "fiscal cliff" debate is over or when there seem to be a more predictable federal tax policies for workers, businesses and investors?

This third real GDP growth estimate for Q3 2012 is a little unusual in that it has increased twice since the first (advance) estimate made in October.  In October, the estimate was a 2.0 percent growth rate.  In November, the estimate was increased to 2.7 percent. The December estimate increased to 3.1 percent.

"The GDP estimate released today is based on more complete source data than were available for the "second" estimate issued last month. In the second estimate, the increase in real GDP was 2.7 percent (see "Revisions" on page 3). The third estimate has not greatly changed the general picture of the economy for the third quarter except that personal consumption expenditures (PCE) is now showing a modest pickup, and imports is now showing a downturn."

BEA comment on the Q3 revisions: "The "third" estimate of the third-quarter percent change in real GDP is 0.4 percentage point, or $14.4 billion, more than the "second" estimate issued last month, primarily reflecting an upward revision to personal consumption expenditures, a downward revision to imports, and upward revisions to exports and to state and local government spending."

Look at the real GDP growth for the four quarters of 2010, in Figure 1.  In 2010, growth was amazingly even throughout the year.  Compare this to 2011 when the growth rate jumped up and down over the four quarters.

Students: Make sure you understand how fiscal policies (taxes and spending) and monetary policies (Federal Reserve policies to influence interest rates and the money supply) are intended to influence the growth of the economy. You should be able to explain how policies that increase spending and borrowing are intended to stimulate the economy.

For a review of these policy options, you can use the Kahn Academy video program, "Monetary and Fiscal Policy." URL: www.khanacademy.org/finance-economics/macroeconomics/v/monetary-and-fiscal-policy

Where did the Q3 Growth Come From?

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

"The acceleration (change in the rate of growth) in real GDP in the third quarter primarily reflected upturns in private inventory investment and in federal government spending, a downturn in imports, an upturn in state and local government spending, and an acceleration in residential fixed investment that were partly offset by a downturn in nonresidential fixed investment and a deceleration in exports."

Key Industries in Q3

Take a look at Tables 2 and 3 of the December 20, 2012, press release.  (www.bea.gov/newsreleases/national/gdp/2012/pdf/gdp3q12_3rd.pdf   Scroll down to Table 2.)  On this table you will see the contributions to Q3 real GDP growth broken-down by major industry category.

Students: Do you see any patterns or key categories?  Take notice of the size of each category in the total economy.   A high growth rate for a small industry group may be less meaningful than a smaller increase in a large industry group - especially if it employs far more people.

In the announcement, the BEA specifically mentions the growth rate in computers and automoblies. "Final sales of computers added 0.11 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 0.25 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 mentions motor vehicle and computer sales? 

Q3 Growth by Sector

Remember, the make-up of GDP is:

  •      Personal Consumption Spending (PCE)
  •      Non-Residential and Residenital Investment (I)
  •      Government Spending - all levels (G)
  •      Net Exports - Exports minus Imports (X)


"Real personal consumption expenditures increased 1.6 percent in the third quarter, compared with an increase of 1.5 percent in the second. Durable goods increased 8.9 percent, in contrast to a decrease of 0.2 percent. Nondurable goods increased 1.2 percent, compared with an increase of 0.6 percent. Services increased 0.6 percent, compared with an increase of 2.1 percent."

"Real nonresidential fixed investment decreased 1.8 percent in the third quarter, in contrast to an increase of 3.6 percent. Nonresidential structures was unchanged in the third quarter; in the second quarter, structures increased 0.6 percent. Equipment and software decreased 2.6 percent in the third quarter, in contrast to an increase of 4.8 percent in the second. Real residential fixed investment increased 13.5 percent, compared with an increase of 8.5 percent."

"Real exports of goods and services increased 1.9 percent in the third quarter, compared with an increase of 5.3 percent in the second. Real imports of goods and services decreased 0.6 percent, in contrast to an increase of 2.8 percent."

"Real federal government consumption expenditures and gross investment increased 9.5 percent in the third quarter, in contrast to a decrease of 0.2 percent in the second. National defense increased 12.9 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 increased 0.3 percent, in contrast to a decrease of 1.0 percent."

"The change in real private inventories added 0.73 percentage point to the third-quarter change in real GDP, after subtracting 0.46 percentage point from the second-quarter change. Private businesses increased inventories $60.3 billion in the third quarter, following increases of $41.4 billion in the second and $56.9 billion in the first."

BEA Footnote: “Quarterly estimates are expressed at seasonally adjusted annual rates, unless otherwise specified… Real estimates are chained (2005) dollars.”

Students: Business investment decreased in Q3.  What do you think the future impact of lower investment in Q3 might be.

The Business Cycle

The National Bureau of Economic Research (NBER) announced that the recession (a peak in the business cycle) began in December, 2007, and ended (a trough in the business cycle) in June, 2009.  Take another look at Figure 1, above, to see the recession in the recent history of GDP growth.. 

Figure 2, below, shows a typical business cycle model of expansion, peak, decline (possibly a recession) and trough. 

Figure 2

Students:  The business cycle tillustrates the growth pattern of the U.S. economy over the past couple of years - expansion, peak, contraction, and trough.  Are we still in a "trough" despite the NBER announcement of the end of the recession? 

Note: GDP is only one several indicators used by the NBER to identify recessons. Equally important is payroll employment.  A common misundestanding about recessions is that a recession is simply two quarters ot no growth or negative growth.  While that may be generally true is you look at the history of recesions, the NBER uses a more broad series of indicators.

"The Committee does not have a fixed definition of economic activity. It examines and compares the behavior of various measures of broad activity: real GDP measured on the product and income sides, economy-wide employment, and real income. The Committee also may consider indicators that do not cover the entire economy, such as real sales and the Federal Reserve's index of industrial production (IP). The Committee's use of these indicators in conjunction with the broad measures recognizes the issue of double-counting of sectors included in both those indicators and the broad measures. Still, a well-defined peak or trough in real sales or IP might help to determine the overall peak or trough dates, particularly if the economy-wide indicators are in conflict or do not have well-defined peaks or troughs."

Source: National Bureau of Economic Research, Business Cycle Dating Committee, URL: www.dev.nber.org/cycles/recessions.html , September 20, 2010.

Students: Make sure you understand the difference between nominal (current-dollar) and real (constant or chained dollar) GDP measurements. T

GDP vs. GNP

You may hear references to gross national product (GNP) and gross domestic product (GDP).  What is the difference?

The U.S. current-dollar GDP in Q3 2012 (annualized) was $$15,811.0 billion. When adjusted for inflation in chained 2005 dollars, the real Q3 annualized GDP was $13,652.5 billion. Current-dollar GDP increased 5.9 percent, or $225.4 billion, in Q3 2011, after increasing 2.8 percent, or $107.3 billion in Q2.”

Note:  Prior to 1991, the BEA used gross national product (GNP) as the primary measurement of production output. The difference is that GDP is a measurement of production within a country's borders and GNP is a measurement of production by enterprises owned by a country's citizens. Production within a country's borders, but by an enterprise owned by someone from outside the country, counts as part of the country’s GDP. The BEA switched to GDP primarily because most of the other developed nations used GDP at that time, and it made international production output comparisons easier.

Determination of GDP

Figure 3, below, shows how the real GDP growth rate is determined through the National Income and Product Accounts (NIPAs).

Figure 3

Measuring National Income, GNP, and GDP:GDP and Other Macroeconomic Data

It is sometimes instructive to find relationships between various macroeconomic data.  These relationships may sometimes give us a broader picture of the economy. For instance, there is a general relationship between output (GDP) and employment. As GDP increases, employment tends to increase.  In the past several months, as real GDP has decreased, the unemployment rate has increased. One piece of data confirms the meaning of the other.

Figure 4 illustrates four sets of macroeconomic data - CPI, unemployment, real GDP growth and the federal funds rate. Notice the long term relationship of periods of output growth and decline with the changes in the unemployment rate. This relationship makes sense as the number of employed is directly related to output. Some increase in output can be attributed to improvements in productivity, but growth is very much dependent on labor force growth and employment. In late 2008 and 2009, as U.S. real GDP declined, the unemployment rate increased substantially.

figure 4

Inflation and GDP

Accurate measurement of gross domestic product or GDP growth is also dependent on the accurate measurement of inflation. A rise in the price level "inflates" the measurement of GDP growth - miscalculating real growth in the economy. A more meaningful measurement of the growth of output is real GDP - the nominal GDP measurement adjusted for the impact of inflation.  Although CPI is the most common measurement of inflation for many uses, the adjustment of GDP uses a process based on the GDP deflator. Both the CPI and the GDP deflator are measurements of average prices, but the GDP deflator includes all of the goods and services produced in the economy, not just the CPI market basket.

CPI vs. GDP Deflator as Measures of Inflation

The rate of inflation rate determined by the CPI and GDP deflator are normally quite similar.  Since the CPI uses a fixed market basket of goods and services, it assumes a fairly constant pattern of consumer purchases. Over time, the market basket may be changed, based on changes in consumer behavior. The GDP deflator uses a flexible basket of goods and services based on the actual quantities of goods and services produced in a year, while the prices of the goods and services are fixed. The GDP deflator uses a much larger quantity of goods and services.

The CPI does not take into account substitution - the tendency of consumers to choose lower priced goods in place of more expensive ones. Just the opposite sometimes happens, as consumers may choose to purchase more expensive goods as their incomes increase. The GDP deflator can take these substitutions into account.  Because the GDP deflator assumes substitutions, it may underestimate the impact of inflation when consumers do not (are not able to) substitute. The CPI may overestimate the impact of inflation when consumers do substitute.

Most government agencies and many private contracts use the CPI to determine a cost of living adjustments (COLA).  The Social Security Administration added a 5.8 percent COLA to Social Security benefits and SSI payments in January 2009, based on  the percentage increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of 2007 to the third quarter of 2008.  If there had been no increase in the CPI in that time period, there would have been no increase in benefits.

Inflation and Unemployment

Long-standing economic theory had assumed that there is a predictable trade-off between the impact of public policy decisions and economic change on inflation and unemployment. This theory, developed by New Zealand Economist William Phillips in 1958, was based on his observation of an inverse relationship between money wage changes (inflation) and unemployment in the British economy over a period of time. The "Phillips Curve" proposed that when unemployment is low, inflation tends to be high and when unemployment is high, inflation tends to be low.

The implication for policy makers was that "Keynesian" policies could be used to control unemployment and inflation. Increased spending can lower unemployment with the risk of a high rate of inflation.  Policy makers face the Phillips Curve trade-off. Today, policy makers who propose to use monetary policy (lower interest rates) or fiscal policy (deficit spending) to stimulate the economy, and increase GDP and employment, are aware of its potential inflationary effect. The Phillips Cure theory lost favor in the late 1980s when there were periods of both high unemployment and high inflation, followed in the 1990s by periods of low unemployment and low inflation.

The Federal Reserve recognized this potential trade-off in its most recent monetary policy statement when it justified an aggressive stimulatory policy by saying that the current conditions did not include an inflationary threat. Low inflation provides room for aggressive policies to stimulate the economy. Should inflation become a real threat, the Fed may slow down growth of the money supply.

Students: Does the Phillips Curve make sense?  Does it apply in this period of time?

Look again at the data in Figure 4 about the recent performance of the U.S. economy. Notice the relationships of real GDP growth, payroll employment (the NBER's key data) and the unemployment rate. CPI data has been included because it is also the subject of monthly "Focus on Economic Data" lessons.

Students:

  • What trends do you see in the four data sets?
  • What generalizations can you make about the trends of the four data sets?
  • Are the real GDP growth and payroll employment trends related?
  • Are the real GDP growth and unemployment rate trends related?
  • Are the payroll employment and unemployment rate trends related?
  • Is the trend of the CPI-U related to the real GDP growth and payroll employment data?
  • Is the trend of the CPI-U related to the real GDP growth and payroll employment data?
  • If you were a member of the NBER "Business Cycle Dating Committee, would you argue that we are still in a recession? 
     

U.S. State, Metropolitan Area, and Regional Real GDP Data

The BEA releases annual GDP data for the U.S. regions, the fifty states and for metropolitan areas. The most recent data was released in September, 2012. The current state and regional area GDP releases are for the year 2011. The metropolitan area release is for the year 2010.

States

"Real gross domestic product (GDP) increased in 43 states and the District of Columbia in 2011, according to new statistics released today by the U.S. Bureau of Economic Analysis (BEA) that breakdown GDP by state. Durable–goods manufacturing, professional, scientific, and technical services, and information services were the leading contributors to real U.S. economic growth. U.S. real GDP by state grew 1.5 percent in 2011 after a 3.1 percent increase in 2010."

Source: www.bea.gov/newsreleases/regional/gdp_state/gsp_newsrelease.htm

Metropolitan Areas

"Real U.S. GDP by metropolitan area increased 2.5 percent in 2010 after declining 2.5 percent in 2009, according to new statistics released today by the U.S. Bureau of Economic Analysis. The economic growth was widespread as real GDP increased in 304 of 366 (83 percent) metropolitan areas, led by national growth in durable-goods manufacturing, trade, and financial activities."

Source: www.bea.gov/newsreleases/regional/gdp_metro/gdp_metro_newsrelease.htm

Regions

"Real GDP increased in all eight BEA regions in 2011, although growth slowed in most regions. The Far West (2.1 percent) was the only region where growth accelerated. The Southwest region grew the fastest (2.7 percent), led by Texas with a 3.3 percent increase."

Source:BEA: GDP by State www.bea.gov/newsreleases/regional/gdp_state/gsp_newsrelease.htm

Students: Compare your state or region to other states and regions. What factors may have influenced the pace or growth in your state or region? What industries are growing or declining in your state or region?]

CONCLUSION

Once again:

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

U.S. economic growth was a little faster in Q3 than previous estimates. The ongoing debate is over whether or not the government should take further stimulatory actions or let the economy recover on its own?  Ask the almost 12 million workers who continue to be unemployed. 

Watch the continuing discussion about Federal Reserve monetary policy and fiscal policies - taxes and spending.  The big question - as of the time of writing this lesson - is the "fiscal cliff."  How will Congress address deficit spending and the resulting debt.  Will taxes be increased? If so, who pays more?  Will the budget be cut?  If so, what programs will lose funding?

Students?  What should be done through monetary and fiscal policies to get the U.S. economy back on track?

ASSESSMENT ACTIVITY

EXTENSION ACTIVITY

The U.S. Central Intelligence Agency (CIA) “World Factbook” ranks the world's 228 nations by various economic measures, including gross domestic product. The  largest of the national economies in the current edition are listed below, in Figure 5.  All data in this figure are for 2011.

NOTE: The CIA GDP data is reported using “purchasing power parity” a process that determines the relative values of two currencies. It equates the purchasing power of various nations’ currencies and lists them as equivalent to U.S. dollars.

figure 5

In terms of total size of GDP, the U.S. ranks second, just behind the European Union nations’ total.  In terms of real GDP growth rate, the U.S. ranks 157th among the worlds' nations. See Figure 6, below.

Figure 6

In the ranking for GDP per capita, the U.S. ranks 11th among the 228 nations.  See Figure 7, below.  The country rankings may be a bit deceiving, due to great differences in income distribution, price levels, qualitative differences, data collection methodology, etc.

Figure 7

Take a look at the economic data for the world’s nations available from the CIA World Factbook .  What does the data tell you about the various nations?

Students: Choose one nation. Summarize what you perceive is that nation’s “standard of living,” according to its per capita GDP and other measures of social welfare.

 Other ranking of the world's national economies may differ from those estimated by the CIA World Factbook.  For instance, the World Bank estimates the U.S GDP in 2011 as $14,991,200,000,000. (http://data.worldbank.org/indicator/NY.GDP.MKTP.CD?order=wbapi_data_value_2010+wbapi_data_value+wbapi_data_value-last&sort=desc)   The CIA's 2011 estimate of U.S. GDP is $15,080,000,000,000.