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What Exactly IS the U.S. Economy?

By Kimberly Amadeo, About.com

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The U.S. Economy Is That Which 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.

To make sure that GDP can be most accurately compared year-to-year, the Bureau of Economic Analysis (BEA) usually reports real GDP. 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, I checked) only the value of the shoe gets counted.
Current-dollar GDP is the measurement that leaves inflation in the estimate. It is, therefore, much higher than real GDP.

GDP is measured by the BEA quarterly. The BEA revises estimates as it receives better data throughout the next quarter.

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 puchase 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.

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.

Recent GDP Trends:

GDP grew 2.5% in 2003, as the economy began its recovery from the 2000 recession. In 2004, GDP growth rebounded to 3.6%. The effects of Hurricane Katrina in Q4 caused 2005 GDP to slow to a still healthy 2.9%.

The economy recovered from Katrina in Q1 2006 with a growth rate of 4.8%, and housing markets peaked. However, high oil prices during the summer caused the economy to slow below 2.5% for the rest of the year. GDP growth was 2.4% for Q2, 1.1% for Q3 and 2.1% for Q4. As a result, overall 2006 GDP growth was 2.8%, about flat with 2005 growth. (Source: BEA, GDP News Release 1/29/08)

In 2007, the economy stunned analysts by slowing to .1% in Q1 as the housing market started to decline. However, a declining dollar boosted exports, driving GDP growth to 4.8% in Q2 and in Q3. However, the Subprime Mortgage Crisis caused growth to decline to -.02% in Q4, which slowed GDP growth to only 2% for the year.

GDP for 2008 was predictably sluggish: .9% in Q1, a slight rise to 2.8% in Q2, falling to -.5% in Q3. Most analysts expect Q4 GDP growth to be negative, as well. The Congressional Budget Office (CBO)forecasts 2008 GDP growth to be 1.2%. (Source: GDP Current Statistics)

GDP Outlook:

The CBO forecast U.S. GDP growth in 2009 to be a negative 2.2%, growing slowly to 2.2% in 2010. It then predicts that GDP growth will rebound to 4.2% in 2011. That seems unlikely, given the huge debt that the U.S. will be saddled with as it tries to grow out of this recession. (Source: CBO, "The Budget and Economic Outlook: Fiscal Years 2009-2019", January 2009)

(Article updated January 14, 2009)

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