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What Is GDP?

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(Credit: Bill Pugliano/Getty Images)

The U.S. Economy Is Measured by G.D.P.:

The best way to understand the U.S. economy is by looking at Gross Domestic Product (GDP), which is the statistic used to measure the economy. In other words, the U.S. economy, as measured by GDP, is everything produced by all the people and all the companies in the U.S. In 2010, it was $14.7 trillion.

To make sure that GDP can be most accurately compared year-to-year, the Bureau of Economic Analysis (BEA) usually reports real GDP.

Nominal GDP is the measurement that leaves inflation in the estimate. It is, therefore, much higher than real GDP.

How GDP Is Calculated:

To calculate real GDP, the BEA makes three important distinctions:
  1. Imports and income from U.S. companies and people from outside the country are not included, so the impact of exchange rates and trade policies don't muddy up the number.
  2. The effects of inflation are taken out.
  3. Only the final product is counted, so that if someone in the U.S. makes shoelaces, and it is used to make shoes in the U.S. (there are a few companies left!) only the value of the shoe gets counted.

GDP Growth Rate:

GDP is measured by the BEA quarterly. The BEA revises estimates as it receives better data throughout the next quarter. To compute economic growth, it compares each quarter to the previous one. For a summary of all GDP growth reports since Q4 2006, see GDP Current Statistics

How GDP Affects the US Economy:

GDP is important for three reasons:
  1. Most importantly, it is used to determine if the U.S. economy is growing more quickly or more slowly than the quarter before, or the same quarter the year before.
  2. It is also used to compare the size of economies throughout the world.
  3. It is to compare the relative growth rate of economies throughout the world.
Investors look at GDP growth to see if the economy is changing rapidly so they can adjust their asset allocation. In addition, investors compare country GDP growth rates to decide where the best opportunities are. Most investors like to purchase shares of companies that are in rapidly growing companies.

The Federal Reserve (Fed) uses the GDP growth rate as one of the indications of whether the economy needs to be restrained or stimulated. (See The Federal Funds Rate and How It Works).

How GDP Affects You:

For example, if the GDP growth rate is speeding up, the Fed may raise interest rates to stem inflation. In this case, you would want to lock in a fixed-rate mortgage, because you know that an adjustable-rate mortgage will start charging higher rates next year.

If GDP is slowing down, or is negative, then you should dust off your resume. Declining GDP usually leads to layoffs and unemployment, but it can take several months. Declining GDP means business revenues are down. It can take awhile before executives can put together a layoff list and package. If you follow GDP statistics, you can be better prepared.

You could also use the GDP report from the BEA to look at which sectors of the economy are growing and which are declining. This would help you determine whether you should invest in, say, a tech-specific mutual fund vs a fund that focuses on agribusiness. It can also help you find training in sectors that are growing. Even during the Great Recession, healthcare- related industries continued to add jobs.

Recent GDP Trends:

In 2008 and 2009, the economy contracted for four consecutive quarters. The last time this happened? The Great Depression. The economy fell 1.8% in Q1 2008 with the Bear Stearns bailout, but resumed 1.3% growth by Q2. When the banking system imploded in the third quarter, the economy shrank 3.7%. The Lehman Brothers collapse delivered a crippling blow--the economy dropped 8.9% in Q4, contracting .3% for the year. GDP plummeted 6.4% in Q1 2009. By the second quarter, the economic stimulus package started to work: the economy shrank only .7% in Q2. It finally grew 2.2% in Q3 and 5.6% in Q4.(Source: GDP Current Statistics)
The financial crisis was worse than the 2000 recession, which was over by 2003 when the economy grew 2.5%. It expanded 3.6% in 2004, and was slowed only briefly (2.9%) by Hurricane Katrina in 2005. By March 2006, the economy peaked at 4.8%, driven by the housing bubble. By the end of the year, the economy only grew 2.7%.

When the housing bubble broke, the economy only grew 1.2% in the first quarter of 2007. A falling dollar boosted exports, spurring growth to 3.2% in the second and 3.6% in the third quarters. When the Subprime Mortgage Crisis hit in October, growth slowed to 2.1%. Overall, the economy expanded 2.1% in 2007.

GDP Outlook:

The Philadelphia Federal Reserve predicts that GDP will grow 1.7% in 2011, 2.6 percent in 2012, and 2.9 percent in 2013. That seems reasonably conservative for three reasons:
  1. First, the $14 trillion national debt the U.S. is saddled with will limit further fiscal stimulus.
  2. Home prices will stay flat through 2011, thanks to an 15-month pipeline of homes going into foreclosure.
  3. Commercial real estate will experience continued weakness through 2011.
Unfortunately, growth needs to be 3% or greater to really stimulate job creation. Therefore, unemployment will probably stay at around 9% in 2011, which will limit demand and keep growth flat. Growth will come from companies that export to growing emerging market countries. (Source: Philadelphia Federal Reserve

(Article updated September 5, 2011)

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