Tools For Measuring the Health of the Economy

Economic indicators are used to measure the financial health of the economy. There are many methods and tools for measuring the economy and every economist has his favorite method. The health of the economy is measured by tracking certain indicators. Different economists use these indicators in various combinations. Some economists place more or less weight on different ones in making their predictions about which direction the economy will go. It is important to note the differences in measurement when assessing the opinions of popular economists of today.

This paper will be primarily concerned with the indicators, which would indicate whether we are currently in an inflationary economy or a deflationary economy. A recession occurs when real GDP declines for two successive quarters. However, the National Bureau of Economic Research (NBER) officially defines a recession as a “significant decline in activity spread across the economy, lasting more than a few months.” That becomes a depression when the GDP decline is protracted (Clifford, 2001). This difference in definition is why one hears news broadcasters fail to agree as to whether we are in a recession or not. It may meet one definition, but not the other.

According to Forbes Magazine, February 28, 2002, the GDP has grown consistently throughout 2001, though sometimes this growth may have been slow. The only time when the GDP decreased was third quarter 2001 when it dropped 1.3%. It quickly recovered and has shown strong growth since that time (Morrison, 2002). The drop in the GDP in the third quarter of 2001 may have been due to the terrorist attacks on the , which shook consumer confidence in certain sectors, especially the transportation industry.

At the close of the day April 22, 2002 the inflation rate was 1.32, the GDP growth was 1.70, the Unemployment rate was 5.70, gold was at 303.70 per troy ounce and The Prime lending rate was 4.75. These numbers are according to the Financial Forecast Center (2001). Unemployment way up.1 from last quarter, but was down from 5.8 at the same time last year. This is relatively steady.

Now let us examine the various indicators that help to determine the rate of inflation or deflation. The is the most visible measure of inflation. It measures the cost of buying a fixed “market basket” of goods and services over time. Since it assumes that consumers maintain identical buying patterns even if prices rise, it tends to overstate inflation.

The Core CPI excludes the purchase of energy and food, making it a less volatile. The Employment Cost Index measures change in cost of labor. This is a key inflation indicator, as prices will rise as the cost to producer’s increases.

The Gross Domestic Product (GDP) measures the total output of goods and services in the U.S. Many economists believe that a real GDP growth rate much higher than 2.5% may lead to inflation, although this wasn’t the case in the late ’90s. The Producer Price Index measures whether producers are getting more or less for their goods, indicating inflation at the wholesale level, which in turn means consumers will pay higher prices.

The Leading Economic Indicators (LEI) area weighted index of 10 indicators (the S&P 500, housing permits, and others). Three consecutive months of decline might signal a recession. These are the factors that the government officials use to determine economic policy in the United States and economists use to make their predictions. When unemployment is low, leaders focus on the labor market including the employment cost index and workers’ average hourly earnings. When the economy seems weaker, they focus on potential growth areas, such as durable goods orders, consumer confidence, and the yield curve (Clifford, 2001).

The current expansion has challenged conventional wisdom about the business cycle and the relationship of strong growth and low unemployment to inflation. As a result, many economic models built during previous cycles are being revised to better make predictions in the current cycle. Economists use these models to predict the general direction of the economy and to try to guess what actions the Federal Government will make to try to curb or boost the economy via their policy decisions.

One model currently back on Wall Street’s drawing board is the Taylor Rule, which we first wrote about in September 1997. Introduced by Stanford professor John Taylor, the rule attempts to infer an from current economic conditions. It starts with a real rate, without adjustment for inflation, that represents a neutral monetary policy. To this “equilibrium” rate is added the current inflation rate plus two equally weighted factors: the output gap and the inflation gap. The implication is that if the economy grows more quickly or prices rise more rapidly than the Federal Reserve is comfortable with, it will raise the funds rate (Hester 1999).

Economists compare the dip in the economy of third quarter last year to several other important periods in American history. These are the Cuban Missile Crisis, the Gulf War, the World Trade Center bombing and the . Looking at the , one-month, three-months and six-months after each event, the Gulf incident is the one that most closely matches the market performance since Sept. 11 (Canto, 2002).

In an article for American City Business Journals, Todd Buchholz, a former economic advisor to President George H.W. Bush, indicates that new home sales have prevented a deep recession from occurring. He states that lower interest rates are now making it possible for people who previously could not afford a home to purchase one. He says that this is especially true among minority buyers (Schroeder, 2002). This is an example of one segment of the market having a tremendous effect on the economy as a whole. Some blame the transportation sector for the drop in third quarter of 2001.

Making such predictions and accusations can be risky, however, because the indicators are designed so that one element does not have enough weight to drag down the entire economy. It may have an effect, however, it would take a major event for one segment to “crash” the economy. The news media is famous for making these types of claims and blaming one sector or another for either boosting or dragging the economy. A good example is in early 2000 when the technology sector was blamed for “fueling” the economic growth. The real situation is the tech sector growth did have a small boosting effect on the other sectors, however did not carry it by itself. It did have the effect of boosting consumer confidence, leading to growth in other sectors, which had the overall effect of boosting the economy.

Economic indicators are an important tool for measuring the health of the economy, but we must be careful to look at the entire picture and not place too much weight on one factor.

The best way to forecast the economy is to compare it to past events with similar situations. It is important to know what the different factors are and how they are measured. We are currently in a period of inflation, however, however, this inflation is slight. Consumer confidence is rising and things look like smooth sailing through 2002.

Works Cited

Canto, Victor A. Crisis Revisited. Bizjpirnals.com. 2002. http://sanjose.bizjournals.com/sanjose/stories/2002/03/04/daily12.html. Accessed April

Clifford, Stephanie. How to keep tabs on the United States economic health.

Cheat Sheet: A Civilian’s Guide to the Economy. 2002 Business 2.0 Media Inc. August 2001 Issue. http://www.business2.com/articles/mag/0,1640,16701|5,FF.html. Accessed Hester, William. Focus on Fed Funds. Bloomberg.com. October 1999. http://www.bloomberg.com/personal/archives/mw_A9910_econ.html. Accessed April 22,

Morrison, Joanne UPDATE 1-U.S. fourth-quarter GDP growth revised higher. Reuters News

Service. Forbes Magazine. February 28,2002. http://www.forbes.com/newswire/2002/02/28/rtr527008.html. Accessed April 22, 2002

Schroeder, K. Home Sales Prevent Recession. American City Business Journals. February 22, 2002 print edition

The Financial Forecast Center. Market Research International 2001. http://www.forecasts.org/.

Accessed April 22, 2002