Essay Instructions: Business Cycles and Economic Outlook
Focus on Economic Data: U.S. Real GDP Growth, March 26, 2009*
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. Understanding the level and rate of growth of the economy's output (GDP) helps to better understand employment trends, the health of businesses, and consumer well-being.
This "Focus on Economic Data" lesson focuses on the BEA “final” estimates released March 26, 2009, for the fourth quarter (October, November, and December) of 2008.
Goals of this SLP Assignment:
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 real GDP data relative to the indexes of leading, coincident, and lagging indicators.
Speculate about the nature and impact of current economic conditions and implications for the future.
Process:
The March 26, 2008, BEA Announcement: Real Gross Domestic Product:
"Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- decreased at an annual rate of 6.3 percent in the fourth quarter of 2008, (that is, from the third quarter to the fourth quarter), according to final estimates released by the Bureau of Economic Analysis. In the third quarter, real GDP decreased 0.5 percent."
U.S. real gross domestic product (real GDP) decreased in the fourth quarter (Q4) of 2008 at a slightly greater rate than the BEA's preliminary estimate made in February. GDP quarterly estimates are made in three consecutive months following each quarter. Each estimate is based on more recent and/or accurate data. The BEA explained, "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 decrease in real GDP was 6.2 percent."
The BEA announcement attributed the decrease in real GDP in the fourth quarter to "negative contributions from exports, personal consumption expenditures, equipment and software, and residential fixed investment that were partly offset by a positive contribution from federal government spending. Imports, which are a subtraction in the calculation of GDP, decreased."
"Most of the major components contributed to the much larger decrease in real GDP in the fourth quarter than in the third. The largest contributors were a downturn in exports and a much larger decrease in equipment and software. The most notable offset was a much larger decrease in imports."
Providing more detail, the BEA added, "Final sales of computers subtracted 0.02 percentage point from the fourth-quarter change in real GDP after subtracting 0.01 percentage point from the third-quarter change. Motor vehicle output subtracted 2.01 percentage points from the fourth-quarter change in real GDP after adding 0.16 percentage point to the third-quarter change."
The chart below shows the level of U.S. nominal (current dollar) and real GDP for the past two years. Note the increases in early 2007 and the first decrease in Q4 of 2007. GDP increased in the first half of 2008 and the current trend of declines began in the second half of 2008.
Year
Quarter
Nominal GDP
Real GDP
2007
Q1
13,510.9
11,357.8
Q2
13,737.5
11,491.4
Q3
13,950.6
11,625.7
Q4
14,031.2
11,620.7
2008
Q1
14,150.8
11,646.0
Q2
14,294.5
11,727.4
Q3
14,412.8
11,712.4
Q4
14,200.3
11,522.1
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. Recessions, a "significant decline in economic activity spread across the economy, lasting more than a few months," are identified by the National Bureau of Economic Research "Business Cycle Dating Committee." In addition to real GDP, the key measurements in the determination of a recession are real income, employment, industrial production, and wholesale-retail sales.
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 GDP “fell slightly in 2007Q4, rose slightly in 2008Q1, rose again in 2008Q2, and fell slightly in 2008Q3… “the currently available estimates of quarterly aggregate real domestic production do not speak clearly about the date of a peak in activity.”
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.”
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."
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." For more information: www.conference-board.org.
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 announced March 19, 2009. Link: www.conference-board.org/economics/bci/pressRelease_output.cfm?cid=1 Retrieved November 15, 2009.
"The Conference Board Leading Economic Index™ (LEI) for the U.S. decreased 0.4 percent, The Conference Board Coincident Economic Index™ (CEI) decreased 0.4 percent and The Conference Board Lagging Economic Index™ (LAG) decreased 0.4 percent in February.
"The Conference Board LEI for the U.S. declined in February, following a slight increase in January. The monthly increase for December was revised to a small decline, while January's monthly increase was revised lower, due mainly to data revisions in manufacturers' new orders and real money supply. Between August 2008 and February 2009, the index fell 2.1 percent (a -4.1 percent annual rate), faster than the decline of 1.6 percent (a -3.1 percent annual rate) for the previous six months. In addition, the weaknesses among the leading indicators have remained widespread in recent months.
The Conference Board CEI for the U.S. fell again in February, driven by continued declines in employment and industrial production. Between August 2008 and February 2009, this index of current economic activity dropped 3.1 percent (a -6.1 percent annual rate), a much larger fall than the decrease of 0.9 percent (a -1.9 percent annual rate) for the previous six months, and the weaknesses among its components have remained widespread in recent months."
"The Conference Board LAG for the U.S. declined by the same amount as the coincident economic index this month, and as a result, the coincident to lagging ratio was unchanged. Meanwhile, real GDP fell at a 6.2 percent annual rate in the fourth quarter of 2008 (following a decline of 0.5 percent annual rate in the third quarter), the largest quarterly contraction since 1982."
"Amid widespread deterioration among its components, The Conference Board LEI for the U.S. continued the general downward trend that began in July 2007. But, its rate of decline has moderated slightly in recent months. Meanwhile, The Conference Board CEI for the U.S. remains on a downtrend that began in November 2007, with the decline in the index having accelerated in recent months. The six-month decline in the CEI is the largest since 1975. Taken together, the behavior of the composite economic indexes suggests that the economic recession that began in December 2007 will continue in the near term."
For more information on economic indicators, go to the "Business Cycle Indicators Handbook," produced by the The Conference Board. The leading, coincident, and lagging indicators are explained on page 13. Link: www.conference-board.org/pdf_free/economics/bci/BCI-Handbook.pdf Retrieved November 15, 2009.
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.
Coincident indicators, such as employment, production, personal income, and manufacturing and trade sales, measure current aggregate economic activity
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
The 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.
Leading Indicators:
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
Coincident Indicators:
Employees on nonagricultural payrolls
Personal income less transfer payments
Index of industrial production
Manufacturing and trade sales
Lagging 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 (%)
More details from the February 2008 real GDP, from the BEA announcement
Real GDP is summarized as the total of four components: personal consumption expenditures, net private investment, government expenditures and net exports. In Q4, the results for the four components were:
"Real personal consumption expenditures decreased 4.3 percent in the fourth quarter, compared with a decrease of 3.8 percent in the third."
"Real nonresidential fixed investment decreased 21.7 percent, compared with a decrease of 1.7 percent. Nonresidential structures decreased 9.4 percent, in contrast to an increase of 9.7 percent. Equipment and software decreased 28.1 percent, compared with a decrease of 7.5 percent. Real residential fixed investment decreased 22.8 percent, compared with a decrease of 16.0 percent."
"Real exports of goods and services decreased 23.6 percent in the fourth quarter, in contrast to an increase of 3.0 percent in the third. Real imports of goods and services decreased 17.5 percent, compared with a decrease of 3.5 percent."
"Real federal government consumption expenditures and gross investment increased 7.0 percent in the fourth quarter, compared with an increase of 13.8 percent in the third. National defense increased 3.4 percent, compared with an increase of 18.0 percent. Non-defense increased 15.3 percent, compared with an increase of 5.1 percent. Real state and local government consumption expenditures and gross investment decreased 2.0 percent, in contrast to an increase of 1.3 percent."
"The real change in private inventories subtracted 0.11 percentage point from the fourth-quarter change in real GDP, after adding 0.84 percentage point to the third-quarter change. Private businesses decreased inventories $25.8 billion in the fourth quarter, following a decrease of $29.6 billion in the third quarter and a decrease of $50.6 billion in the second."
Go to the full BEA announcement for a more detailed breakdown of the data by category (Table 1.) Link: www.bea.gov/newsreleases/national/gdp/2009/pdf/gdp408f.pdf Retrieved November 15, 2009.
Recent government policy decisions to stimulate the economy are aimed at stimulating one or more of the components - consumer spending, investment, government spending or net exports. The overall goal is to stimulate aggregate demand. Aggregate demand is the total amount of goods and services demanded in the economy at a given overall price level and in a given time period. It is represented by the aggregate demand curve, which illustrates the relationship between price levels and the quantities of output that are demanded. Aggregate demand can also be called total spending.
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
Conclusion:
The decline in GDP during the fourth quarter of 2008 was broad-based. Only the government expenditures category contributed positively, as government spending replace a small portion of the slowdown in private spending and investment. "Real federal government consumption expenditures and gross investment increased 7.0 percent in the fourth quarter."
The Conference Board's Index of Coincident Indicators for February 2009 (-0.4 percent) was consistent with the downturn identified by the BEA in Q4. "Driven by continued declines in employment and industrial production."
Assignment
In a 2-3 page paper, please address the following issues:
1. Take another look at the list of "Leading Economic Indicators" from the lesson. Which indicators do you think are the best indicators of the future health of the economy? Explain.
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
2. Research ONE of these leading indicators. Summarize what it tells us about the future.
3. This exercise demonstrated that the change in the real GDP growth rate in Q4 2008 was -6.3%. Using what you have learned in the previous modules, if you were an advisor to President Obama, what types of policies would you advocate to stimulate the economy?
4. Do you consider your views to be more aligned with a classical or Keynesian approach to economic thinking? Explain. (There is no right or wrong answer). See module 1 for resources if needed.
* This lesson is a courtesy of the Council of Economic Education
SLP Assignment Expectations:
Use concepts from the modular background readings as well as any good quality resources you can find from the cyberlibrary or other internet search engines. Please be sure to cite all sources within the text and a reference list at the end of the paper.
