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July 31, 2008

Components of GDP

By: Wade Rousse

Gross Domestic Product (GDP) has four components:

  1. Personal consumption expenditures (C)
  2. Gross private domestic investment (I)
  3. Government consumption and gross investment (G)
  4. Net exports to foreigners (NX)

If you were to put these into an equation substituting “Y” for GDP, what would it look like?

Voila! Y=C+I+G+NX (the infamous GDP equation).

Memorize this equation and you’ll be well on your way to understanding the macro-economy.

This morning, the Bureau of Economic Analysis (BEA) released its 2008 advance second quarter GDP figure. This figure could be revised on August 28 if newer data suggest inaccuracies (hence the “advance”).

The BEA’s report stated that the annualized growth rate was 1.9 percent. How much did each component contribute to this growth?

  • “C” added approximately 1.1 percent
  • “I” subtracted approximately 2.3 percent
  • “G” added approximately 0.7 percent
  • “NX” added approximately 2.4 percent

If you add these together, you’ll get a second quarter annualized growth rate of 1.9 percent.

Notice the contribution of consumption (C) to last quarter's growth. Were the stimulus checks partially responsible for this upswing? If so, during the third quarter — when there are no stimulus checks — what’s going to happen to the “C” in our equation?

Additionally, this morning's release also revised the GDP growth rate for the fourth quarter of 2007 to a negative 0.17 percent. This means our current economic slowdown now has at least one negative quarter of GDP growth. Is talk of recession poised to resurface?

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Posted by Wade at 3:49 PM | Comments (10)

July 25, 2008

Please Keep Speculating….

I spend much of my time planning educational programs emphasizing the Fed’s role in your daily lives. But perhaps what you may not fully appreciate is your importance to the Fed. No, this is not a cheap trick to have you post comments (alright – maybe a little).

Think about speculators. Wade recently posted comments on the criticism focused on these folks who take risks in hopes of receiving a gain. Taking risks involves interpreting information and then weighing the costs and benefits. In essence, economics is learning how to judge costs versus benefits more effectively.

Herein lies the wonder of speculators – Many of them trade on public exchanges, in dozens of languages, on laptops, in university libraries, at retirement homes or on fancy boards at the Chicago Board of Trade. If assumed to be rational, the sum of all these traders’ calculated bets should be a good source of judgment on information. Instead of criticizing them, perhaps we should view them as careful arbiters of information for hints on what is really happening.

Now I know you’re thinking – How do I fit into all this? Well, here at the Fed, we interpret and judge the overall health of the economy. The only hiccup is that maybe we don’t just interpret and judge information. We have the power to create information by setting monetary policy and then releasing information about our policy discussions. You have access to much of the same data and can “speculate” about what we should do. The difference is your actions don’t change expectations about what will happen. So, are you perhaps a more objective arbiter of information than the Fed? Should the Fed look to you for some hints….

…. Happy Speculating…

By: Cindy

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Posted by Cindy at 3:52 PM | Comments (3) | TrackBack

July 21, 2008

Leading Economic Indicators

The Conference Board this morning announced a decrease of 0.1% in June in the index of leading economic indicators. The index is simply a weighted average of the 10 indicators listed below. You’ll notice some contain words such as “permits” and “new orders.” Indicators with words like that typically are good for forecasting future economic activity.

Leading Index (Factor)

1 Average weekly hours, manufacturing. (0.2552)
2 Average weekly initial claims for unemployment insurance. (0.0307)
3 Manufacturers' new orders, consumer goods and materials. (0.0773)
4 Index of supplier deliveries – vendor performance. (0.0668)
5 Manufacturers' new orders, nondefense capital goods. (0.0183)
6 Building permits, new private housing units. (0.0271)
7 Stock prices, 500 common stocks. (0.0391)
8 Money supply, M2. (0.3550)
9 Interest rate spread, 10-year Treasury bonds less federal funds. (0.1021)
10 Index of consumer expectations. (0.0284)

Combine the performance of the 10 together and you have an index that’s a good tool to predict economic growth. A general rule of thumb is that the economy will dip into a recession if the index declines three months in a row. Since 1959, the index has forecasted all seven recessions. However, it has also predicted five recessions that never happened. Therefore, people often joke that the index has accurately predicted 12 of the last seven recessions (a little economist humor).

After five months of decline, the index either rose or was unchanged in the three months before June. Taking all of this into account, the Leading Index is, at the very worst, currently forecasting a mild recession. How does this compare with your forecast?

By: Wade Rousse

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Posted by Wade at 5:12 PM | Comments (0) | TrackBack

July 17, 2008

Cross Price Elasticity of Demand

WOW… there’s a scary term. Sometimes I’m perplexed when students and most of the general public are intimidated by economic jargon, but terms like “Cross Price Elasticity of Demand” help me understand why.

So what is it? Well, it’s simply the degree to which the demand for one product can change in response to a change in price of another good.

Here’s an example: Gas prices are up. In response, demand for scooters is up an amazing 23.6% in the first quarter of 2008. The demand for scooters is responding very positively to the price of gas. That’s “Cross Price Elasticity of Demand,” a fairly simple concept with a somewhat confusing name.

So, is anyone planning to buy a scooter…or perhaps to invest in Honda instead of General Motors?

By: Wade Rousse

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Posted by Wade at 3:30 PM | Comments (6) | TrackBack

July 10, 2008


A friend of mine in the construction business recently heard a politician make reference to a “supply-sider.” My buddy said he hates it when politicians blurt out economic terms that he doesn’t think people understand. After all, he says he doesn’t randomly toss around construction terms like “hoist drum,” “snatch block,” or “swing brakes.”

That made me think others might not fully understand the term “supply-sider.” Simply put, it’s someone who endorses supply-side economics. Marginal tax rates and the Laffer curve are enormously important to supply-siders. They argue that if the marginal tax rate (the tax paid on the last dollar earned) was 100%, obviously no one would have an incentive to continue working because they would be donating all of their future earnings to the government. In fact, people might lose their incentive to work when the marginal tax rates is 60% or 50% or maybe even 40%.

Supply-siders argue giving people incentives to work and produce creates economic growth. They say the way to do this is to reduce the marginal tax rate. But remember, because of the time needed to allow supply-side economics to work, it should be considered a long-run output strategy and not a (business cycle) stabilization tool like monetary policy. Therefore, some economists are proponents of supply-side economics and active monetary policy. Contrary to popular belief, these two are not conflicting viewpoints.

Well, enough for today, but let me leave you with a question: Are you a supply-sider?

By: Wade Rousse

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Posted by Wade at 9:53 PM | Comments (2) | TrackBack

July 8, 2008

The Difference Between “Real” and “Nominal” GDP”

Gross Domestic Product (GDP) enables a national economy to measure its performance. GDP is the market value of all final goods and services produced within a country during a specific time period – usually a year. But be careful. This refers to what’s called “nominal” GDP. That means it doesn’t take into consideration the fact that prices go up and down over time.

In order to make a meaningful assessment of a nation’s performance, we must analyze “real” GDP. That means it’s adjusted for inflation. Or more simply, it does take into account changes in prices.

Consider a country that produces only cigars. (By the way, I confess I have a weakness for a good “stogie”). If the nation produces and sells 100 cigars and charges $10 each, its “nominal” GDP is $1000. Now suppose the following year, everything remains constant except – for whatever reason – it’s able to charge $11. That translates into a “nominal” GDP of $1100.

But is the nation more productive? Of course not…it still makes only 100 cigars a year. Though the market value of the nation’s production, or “nominal” GDP, has changed, “real” GDP has not.

Any suggestions out there for a better way to measure a country’s economic performance?

By: Wade Rousse

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Posted by Wade at 3:55 PM | Comments (1) | TrackBack

July 2, 2008

“Speculator” not a dirty word

Something is bothering me. It’s the bad rap “speculators” are getting these days because of skyrocketing oil prices. I feel compelled to defend these speculators, some of whom are my former colleagues – good ‘ole floor-traders. The politicians and pundits blaming them for high gas prices don’t seem to understand how they contribute to smooth market functioning.

Speculators are the reason an Iowa farmer has the option to sell his or her product in Chicago well in advance of harvest. While the decision to sell might turn out to be a good or bad one, there’s no doubt speculators are the folks who provided that farmer with the option to manage his or her risk. A good speculator will research supply and demand conditions, predict future prices, and then take future “positions” in products like corn or oil with the intention of making a profit.

Liquidity and price discovery are the benefits of this type of speculation. Think about an online auction. As more and more people take part in the auction, the greater the likelihood the item for sale will be priced accurately. That’s the point where supply and demand comes together. Yet in the current environment some of the legislative proposals being tossed around in Washington would actually reduce the number of speculators in the market. Puzzling…

Oil prices are increasing simply because world demand is growing faster than supply. World oil demand jumped from 82.5 million barrels a day in 2004 to 86.8 million barrels a day in 2007. Yet world supply grew only from 83.4 to 85.5 million barrels a day during that time period. If demand is growing faster than supply, prices rise. The people bashing speculators must be assuming that oil price hikes are the result of someone hoarding oil somewhere. But where’s the evidence?

By: Wade Rousse

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Posted by Wade at 1:43 PM | Comments (6) | TrackBack