Us Economy And Economic Indicators Essay, Research Paper

Daekwon the chef and Rza Shogun, Sergio Suarez, Sylvia Lin, Anne-Sophie Young

Economics Final Report

A Treatise on the Value of Economic Indicators

The US Economy and Economic Indicators

The United States economy is the strongest and the most affluent in the world. Besides having the highest GDP (Gross Domestic Product), the United States has a complex system of regulating economic policy and controlling the money supply. The system also regulates banks and financial institutions, and even has a central bank (Federal Reserve Bank) that decides on significant issues, such as raising interest rates. There are many economic indicators that affect the economy such as the CPI, which is the measure of prices at the consumer level for a fixed basket of goods and services, and the unemployment rate. Other indicators include the GDP, which measures the dollar value of all the goods and services of a nation, retail sales, and the consumer confidence index (CCI).

The CPI is the measure of inflation, and is released every month by the Bureau of Labor Statistics. Prices are collected in 85 cities across the country on thousands of different products and services from establishments of all kinds. It reflects prices of food, clothing, shelter, fuels, transportation fares, charges for doctors? and dentists? service, drugs, and all sorts of other goods and services that people buy for day-to-day living. The CPI is used by the Federal Reserve to analyze the data and act accordingly to the interpretation of it. For example, on May 19, 1999, the Federal Reserve decided to hold interest rates for now but are debating to raise interest rates in the near future because the CPI increased seven-tenths of a percent, the highest in eight and a half years. There are two types of CPI. The CPI-U relates to the urban workers, and accounts for about 80% of the civilian population. The CPI-W relates to the wage earners, and accounts for about 40% of the population. The CPI, a reliable measure of the current state of the economy, is used as a warning for inflation, deflation, and disinflation. The CPI generally increases every year because the standard of living rises through time.

The unemployment rate is also significant in the fact that it measures the percent of the population that are currently not legally employed and are actively seeking employment. Recently, because of the strong, healthy US economy, the unemployment rate was the lowest in peacetime since 1957. Low unemployment correlates to a good economy but it can mean increasing inflation because the workers, who have been working as wages increased, can spend more and drive up prices. More jobs have become available because of economic growth including strong consumer confidence and low interest rates. Too low of an unemployment rate is bad because it will cause inflation due to the wealth effect, which means that people will get richer and richer until inflation sets in. According to the Phillips curve, it was widely believed that as unemployment decreases, inflation would increase. Recently, there has been an anomaly because this theory hasn?t been true. This relationship has not been so prominent due to the recession in foreign markets. Recession in foreign markets can cause an increase in the unemployment rate because factories that export goods to other nations will have to cut down on production because people there cannot buy the products. Inflationary pressures caused the Fed to announce an expected rise in increase rates because of high CPI, but the unemployment rate remains almost fixed at 4.3 percent, which is still low, as well as being a factor in inflation.

The GDP measures the dollar value of a nation?s spending and output in goods and services. The GDP can increase when there are inflationary pressures, which meant that the economy is growing at an unhealthy rate. The GDP, if it has risen dramatically, means that prices will skyrocket and if it falls dramatically, a recession might occur. The GDP is measured by a mathematical macroeconomic formula. The formula is GDP=C+I+G+(X-M). Prior to August 1991, the GNP was used as a nation?s economic indicator, which measured the output of goods and services by US residents anywhere in the world. However, the GDP measures a nation?s economic activity regardless of who owns the productive assets in that country. For example, the output of United States-owned companies based in Australia is considered part of Australia?s GDP rather than part of the U.S. GDP. Also, GDP is difficult to measure because every nation has its thugs that does business illegally, such as in the drug trade or people who smuggle goods in another nation. The C in the formula above is Consumption, the most important sector in the US economy. This sector represents consumer spending, and is more than 65 percent of real, or inflation adjusted, GDP. The I is Investment, which is composed of residential (single family and multi-family housing) and nonresidential (auto factories, computers, oil rigs, etc) and change in business inventories which are either added if there is a surplus or subtracted if there is a drop. Investments take about 15% of the GDP. The G in the equation is Government Spending, which is in federal, state, or local form and it takes up approximately 20% of the GDP. Federal spending is 36% of all government expenditures and are used in entitlements such as Social Security or welfare, 45%, defense such as in buying aircraft carriers or nuclear weapons, 18%, discretionary spending, such as NASA or FBI, 20%, and interest payments, 15%. The (X-M) stands for Net Exports because exports add to the GDP while the imports are subtracted since imports will represent another nation?s GDP. The importance of the trade sector is that it represents 13% of the total spending in the economy. The US currently has a huge deficit on goods and services, where (X-M) is negative, which totals about $150 billion. The GDP, besides measuring the output in terms of goods and services, can measure the standard of living in the world. Economists divide the GDP into the total population to get the GDP per head and convert it into dollars to compare the standard of living between two nations. Surprisingly (to me, Daekwon the chef), nominal GDP, which is not inflation adjusted, subtracted from real GDP, which is, can be used as a secondary inflationary indicator, which is dubbed the ?chain price index?.

Retail sales is also an important indicator because it takes a huge role in the GDP. It roughly takes up two-thirds of the GDP and can even predict the sentiments of the American consumer. In our laissez faire society, where the attitude of consumers are objectively analyzed by greedy capitalist gluttons, low retail sales mean less of a GDP growth, which means slower inflation, and lower interest rates. High retail sales means exactly the opposite. The Census Bureau of the Department of Commerce laboriously collects the retail sales data and analyzes it. From a random survey of retail establishments such as Macys, Nordstrom, or Lord and Taylor?s, retail sales are broken down into two categories, durable and nondurable, with the former accounting for about 40%, and the latter 60%. Retail sales are rather difficult to forecast and the revisions are immense at times. They are highly volatile meaning that the retail sales report has a strong tendency, if not potential, to provide major surprises.

The Consumer Confidence Index is an important economic indicator because it measures the level of confidence in the American consumer in each household. However, these surveys might not be reliable because times and situations of the American consumer can change dramatically. If consumers are concerned about job security, economic conditions, or personal finances, they are prone to spend less and this can cause disinflation and even deflation. Alternatively, if consumers have a good feeling about the economy, the opposite effect will occur. The University of Michigan Sentiment Index is another name for the CCI. This index is derived monthly from a telephone survey of about 500 consumers. Michigan takes the percent of respondents that report better conditions, subtracts the percent that say conditions are worse, and adds 100. Preliminary results are released about two weeks after month-end, with final results available on the last Friday of the month.

Predictions for the economic future via interpretation of economic data

The CPI for April increased seven-tenths of a percent, the highest in eight and a half years. This indicates inflationary pressure because it means that the prices of important consumer items like the price of milk or gasoline went up. Inflation is unhealthy for the economy because a short, fast spurt in the economy might cause the value of the dollar to decrease. This means that the same dollar able to buy a pack of bubble gum prior to inflation will not be able to after the inflation sets in. As prices rise, wages remain constant or even decrease, which would mean a rise in unemployment and inflation would cause higher interest rates and destroy the initiatives of entrepreneurs. The Federal Reserve chairman announced that it would seek to raise interest rates and the meeting would be at the end of this month. The Fed might decide to raise interest rates and this tight monetary policy might hurt the bond market. Alan Greenspan is expected to testify before Congress and state the health of the economy. If during his testimonial he reports about tightening monetary policy, one can expect highly that he would persuade the Board of Governors to vote his way. If interest rates rise, than unemployment might rise as well as the owners might be trying to cut down on wages. The rich, upper classes desire higher unemployment because then interest rates fall and the money they have in stock markets increase due to more economic growth.

According to the data, the CPI has gone up a full 1.2 points in April 1999. One must realize that in a range from the CPI of January 1997 and March 1999, the CPI never jumped over .5 points. It was on April that the CPI leaped 1.2 points and increased seven-tenths of a percent, dangerously high and on the verge of inflating our economy. From the January 1997 CPI to the April 1999 CPI, the average has been 162.225. The April 1999 CPI was 166.2, which is 3.975 higher than the average from January 1997 and including April 1999. Therefore, our group?s conviction is that the CPI indicates inflationary pressure and the move toward higher interest rates should be accelerated.

The fact that the economy is enjoying the lowest unemployment in decades

should be sufficient for economic analysts to predict a resurgence in inflation. However, the recent May 1999 unemployment rate, along with the March 1999 unemployment rate, had been the lowest since the beginning of the fiscal year of 1997. If that?s not cogent enough, the average percentage of the unemployment rate from the beginning of 1997 to May 1999 was about 4.64. The May 1999 unemployment percentage is 4.2. Low unemployment means higher risk of inflation. The mode seems to be 4.5 and the median to be 4.6. The wealth effect and the Phillips curve hypothesize that low unemployment means higher inflation. Therefore, the unemployment statistics reveal that inflation is eminent sometime soon in the near future.

The statistical analysis for the GDP is rather subtle because one should not only measure the billions of chained dollars (nominal GDP) starting from the beginning of 1997 but also the percent change. The rise in the US GDP has been a steady growth from the first quarter of 1997 to the first quarter of 1999, ranging from 7166.7 billions of chained dollars to 7754.7 billions of chained dollars. This means healthy growth of the US economic cell until the first quarter of 1998, where the percent increase in GDP was 5.5 percent, and the fourth quarter, where the percent increase in GDP was 6 percent. I mean it really doesn?t take a rocket scientist to find out that the growth was a malignant tumor! In other words, the rapid growth of the first and fourth quarters of 1998 means that inflation might manifest. I say might because the GDP analysis wasn?t really that thorough and there might be a slight chance that I am overreacting. However, my theory in GDP inflation is that there might be a lag between the rapid growth of GDP and the resurgence of inflation. The high spending and splendid output of a nation at a particular time doesn?t mean inflation right away. So, there might be a lag between the high GDP and inflation. This lag could be short or relatively long but it will come to haunt the American consumer. That rapid growth of first and fourth quarters of 1998 means that the American consumer will soon enjoy the prosperity of the economy, which means easy money but inflation, like a ghost, will appear. As a poetic note to GDP, a good analogy, as pertaining to the lag and the American consumer, can be –after the laughter, I guess comes the tears.

Retail sales, which make up the ?C? in GDP (Consumption) is a real significant indicator to track down the buying power of the consumer as well as checking on inflation. Low retail sales mean slower inflation, less GDP growth, and lower interest rates. High retail sales mean that the opposite of what was mentioned above might be approaching. It seems that the economy now is heading toward faster inflation, more GDP growth, and higher interest rates because the retail sales growth rebounded in May after slowing in April. The buying power of the consumer has been steadily increasing so we can fear inflation on this one too. The retail sales on February 1999, as opposed to January 1999, seemed as if there was a high increase in retail sales in an abrupt manner that can be seen as an inflationary pressure warning. The rough increase of four billion dollars from January 1999 to February 1999 of buying power of the consumer can indicate inflationary pressures.

Finally, the CCI, measures the confidence of the consumer. Looking at the data, I am inclined to say that Americans are a moody people in consumer confidence. From the beginning of 1997 to May 1999, I would have to say the periods of high consumer confidence were more numerous than those that are not. High consumer confidence can also lead to inflation.

We therefore believe that the expected rise in interest rates by the Fed is justified in the fact that it is for the sole porpose of preventing inflation and maintaining a healthy economy.