Economic Indicators: Gross Domestic Product

The Gross Domestic Product (“GDP”) is reported on a quarterly basis by the U.S. Bureau of Economic Analysis at 8:30 am during the last week of January, April, July, and October.  These reports are then followed by two rounds of revisions, each a month apart.   GDP has been recorded and tracked since 1929.

GDP measures the total goods and services produced in the U.S. for any given quarter.  Basically, GDP for any given quarter is calculated by determining total demand for goods and services and then subtracting the change in inventories.  One should note that all quarterly GDP numbers and rates are reported as annualized figures.  Amongst business leaders, politicians, investors, analysts, and economists GDP is considered  the most comprehensive data reflecting the overall health of the economy.  These people all incorporate their observations from the current GDP figures into their decisions regarding future actions.  When GDP figures are released to the public, they are provided in both real and nominal terms.  The nominal GDP figures include the effects of inflation, while the real GDP figures eliminate the price effect and reflect the quantity effect.  GDP consists of the following components: (1) personal consumption expenditures, which represents consumer spending; (2) gross private domestic investment, which is consists of business investments; (3) net exports, which is the difference between what the U.S. sells to other countries and what it buys from other countries; and (4) government consumption expenditures and gross investments, which consists of government spending at the federal, state, and local governments level.

Below the sub-components of GDP are detailed:

Personal Consumption Expenditures (“PCE”), in recent periods, represents nearly 70% of total GDP.  Consequently, lack of spending by consumers can have a rather large impact on total GDP numbers.   PCE consists of the following sub-components:

• Durable Goods are usually relatively larger purchases that are designed to last for three years or more and account for approximately 15% of total PCE. Durable goods tend to be dependent on consumer income, consumer attitudes, and interest rates.  Consequently, durable goods spending can exhibit significant volatility as the economy and attitudes regarding the economy change.  If the economy turns down, then consumers are most likely to postpone or avoid purchasing durable goods.  On the other hand, if the economy begins to climb up, then consumers will probably begin to purchasing  more durable goods.  Since, durable goods tend to be larger purchase many of them are purchased with credit, thus increases in interest rates may restrict and reduce purchase of durable goods.

• Nondurable Goods are items that are not meant to last three years and tend to be needed for daily life.    Consequently, nondurable goods do not experience as much volatility as the durable goods during shifts in the economy.
• Services account for approximately 60% of PCE and like nondurable goods tend to be relatively stable in the face of economic turns.  Supporting this stability are housing and medical services that continue even when income declines.

Gross Private Domestic Investment (“GPDI”), in recent periods,  represents nearly 15% of total GDP and can exhibit extreme volatility depending on attitudes regarding the future economic outlook.  GPDI consists of the following sub-components:

• Fixed Investment includes both nonresidential expenditures and residential spending.  A faltering demand for goods and services will probably be followed by a cut back in business expenditures, which could help lead the economy into a recession.

• Changes in Private Inventories can exhibit extreme volatility, especially during turning points in the economy.  As inventory levels increase, companies may cut down on production until the surplus of goods has diminished significantly.  Consequently, such an increase in inventory levels can pose a threat to continued economic growth. 

Net Exports, in recent periods,  exports have accounted for approximately 10% of GDP, while imports have accounted for nearly 15% of GDP.  When calculating GDP, exports are added to the GDP since they  represent  goods that were made in the U.S., while imports are subtracted from the GDP since they represent goods bought by the U.S. but produced elsewhere.

Government Consumption Expenditures and Gross Investment, in recent periods,  represents nearly 18% of GDP and includes outlays from the federal, state, and local governments.   State and local governments can account for as much as two-thirds of total government outlays, but these outlays are dependent on the current state of the regional economies.  As tax revenues decrease, so do outlays, especially since most states have to maintain balance budgets.

In addition to providing information on total GDP and its four sub-components, the Bureau of Economic Analysis also provides the following metrics within the GDP press release:

Final Sales of Domestic Product represents GDP with the changes in inventories removed, thus providing a better indicator than GDP regarding the actual demand for U.S. products. One should note, that this metric does not discriminate between foreign or domestic demand.

Gross Domestic Purchases represents the total purchases by U.S. consumers and businesses regardless of nation that created the product.

When considering GDP figures one should remember that a real annual growth of between 3.0% to 3.5% is considered the appropriate pace to keep unemployment numbers from increasing.  The reasoning is as follows:  (1) the labor force grows nearly 1% a year; (2) in recent years annual productivity has been increasing approximately 2.5% a year; and (3) add items one and two and the rate is then approximately 3.5%.   This reasoning was also expressed in an interview with Joseph Stigilitz.  If GDP were to grow faster than 3.5% for a significant period of time, then inflation could jump up and the Fed would likely react by increasing interest rates.  Furthermore, one should not ignore the nominal GDP figures since these are more reflective of the profits and sales figures that companies will be presenting.

Finally, some basic rules of thumb for investors are that GDP reported above expectations will usually tend to favor stock prices and hurt bond prices, especially if there is fear of inflation.  Bond prices will benefit usually when the GDP is reported at or below expectations.

Tagged with Bureau of Economic Analysis, Final Sales of Domestic Product, GDP, Gross Domestic Purchases, Gross Private Domestic Investment, Labor Productivity, Net Exports, Personal Consumption Expenditures