GROSS DOMESTIC PRODUCT (GDP)

Market Sensitivity: Medium to high.

What Is It: The foremost report on the health of the economy, GDP measures how fast or slow the economy is growing.

News Release on Internet: www.bea.doc.gov/bea/dn/home/gdp.htm

Home Web Address: www.bea.doc.gov.

Release Time: 8:30 A.M. (ET); advance estimates are released the final week of January, April, July, and

October. Two rounds of revisions follow, each a month apart. ( The Bureau of Economic

Analysis expects to speed up the release of the GDP by two weeks in 2006.)

Frequency: Quarterly

Source: Bureau of Economic Analysis, Commerce Department.

Revisions: Monthly revisions tend to be moderate, though they can on occasion be more substantial.

There are also annual revisions that are normally done at the end of July and reflect more

complete information. Benchmark or historic revisions take place every five years of so with

changes that can go back to 1929 when the GDP series began.

WHY IS IT IMPORTANT

GDP. They are the best-known initials in economics and stand for Gross Domestic Product. This is the mother of all economic indicators and the most important statistic to come out in any given quarter. The GDP is a must-read for many because it is the best overall barometer of the economy’s ups and downs. Forecasters analyze it carefully for hints on where the economy is heading. CEOs use it to help compose business plans, make hiring decisions, and forecast sales growth. Money managers study the GDP to refine their investment strategies. White House and Federal Reserve officials view the GDP as a report card on how well or poorly their own policies are working. For these and other reasons, the quarterly GDP report is one of the most greatly anticipated.

However, trying to decipher the swell of data from the GDP may be intimidating at first. Simply put, the GDP is the total price tag in dollars of all goods and services made in the U.S. It’s the sum value of all hammers, cars, new homes, baby cribs, video games, medical fees, books, toothpaste, hot dogs, haircuts, eyeglasses, yachts, kites, and computers – you get the idea – that were sold in the U.S. or exported during a specific period. Even goods that were not sold but ended up on stockroom shelves are included in the GDP because these products were still assembled. The GDP therefore reflects the final value of all output in the U.S. economy, regardless of whether it was sold or placed in inventory.

By looking at GDP performance over the last 50 years, it becomes clear that the U.S. economy has a natural predilection to grow. Business activity has been expanding far more years than it has been contracting. Though recessions have not disappeared, they are definitely shorter and shallower since World War II, and that is important to the economic and social welfare of the country. The faster and longer the economy grows, the higher the level of employment. With more people working, total household income goes up. This encourages Americans to spend more on goods and services. As consumer spending accelerates, companies will be inclined to speed up their own production and hire additional workers. That, in turn, further increases household income-and-viola!- you have a self sustaining economic expansion. Moreover, the benefits of growth are not just felt inside the U.S. Stronger economic growth stimulates foreign businesses as well. Americans will import more cars, clothing, jewelry, wine, and home electronics from other nations, and that helps revitalize the international economy. Foreign workers will also use some of their additional income to buy more goods from the U.S.

Can this self-generating cycle of growth continue indefinitely? In theory, yes. However, as a practical matter, this system is susceptible to breaking down once in a while as a result of outside shocks, like war, or in the even of a serious imbalance, such as an accumulation of excess inventories or an outbreak of inflation. Fortunately, such events are rare. And even if they occur, the U.S. government has sufficient resources and policy options at its disposal to minimize damage to the economy.

Looking at the GDP report itself, it’s important to note at the outset that the government computes the size of the economy in two ways: one is in nominal dollar terms and the other is in real dollar terms. Let’s review what is meant by these two concepts. Current or (nominal dollars) GDP tallies the value of all goods and services produced in the U.S. using present prices. On the other hand, real (or chained dollars) GDP counts only the value of what was physically produced. To clarify the point, suppose a hat-making factory announces that it made $1 million represents nominal company sales (or current dollars). However, something’s missing. From this figure alone, it’s unclear how they achieved the extra income. Did the factory actually sell 11%, more hats? Or did they sell the same number of hats as the year before but simply raised prices by 11%? If the factory made more money because it increased the price tag by 11%, then in real (or constant dollar) terms, the true volume of has sold this year was no greater or whether it was largely the result of price hikes, or inflation. What you want to see are real increases in economic output, which means that a greater supply of goods and services is available for consumers. Higher real GDP improves that the standard of living of Americans while GDP growth due to inflation erodes living standards because people have to pay more for the same amount of products consumed as before. These two measures of GDP are thus of fundamental importance in economics.

HOW IS IT COMPUTED

The GDP report has been a work in progress since the late 1930s, which makes it one of the longest-running economic indicators around. Calculating the GDP is a mammoth undertaking because we’re talking about an $11 trillion economy. The main responsibility for this task falls on the nonpartisan Bureau of Economic Analysis, which is well suited for the job given its history and experience.

The GDP series is really part of a marvelous national accounting system known as the National Income and Product Accounts (NIPA). That may be a mouthful to say but the idea behind it is actually quite simple. In essence, the NIPA is composed of two complimentary methods of estimating GDP. One side of the ledger is the product account which tallies all goods and services sold. The other side is the income account and it looks at where all the monies generated in the production of GDP end up. After all, if consumers, businesses, and the government are spending $11 trillion a year, someone has got to be getting this income. That’s where the income side of the ledger comes in. It tries to record the disposition of the money that came from the production of those products and services. (How much went to wages and salaries? Proprietor income? Interest income? Profits?). Theoretically the product and income measures should be equal. However, discrepancies between the two often crop up mainly because of the way the statistics are collected. But the differences tend to be minor. By and large, the establishment of America’s NIPA is an extraordinary accomplishment and the envy of the world because of its remarkable accuracy, comprehensiveness, and detailed accounting of America’s massive economy.

So how does the bureau compute GDP? It collets and assimilates economic data from thousands of governmental and private sources. Among the information types sought are monthly retail sales, auto sales, and home purchases. To be sure, not all of the economic data is available at the time of collection. As a result, agency staffers work up reasonable estimates for the first GDP report. Why not wait until all the numbers come in before releasing it? Because investment managers and policy makers want to get information on the economy’s health as quickly as possible, even if some of its components have to be estimated. Few want to wait a full three months to get the final quarterly GDP report. Thus, the BEA runs the quarterly GDP numbers through its computers three times for the public. The first GDP report, known as the advance release, is published four weeks after the quarter ends and offers a rough preview of how the economy behaved in the quarter that just ended. A month later, the preliminary GDP report is announced. It contains some revisions based on information not available ate the time of at the advance release. It’s only at the very end of the subsequent quarter that we see a final GDP report with additional changes in the numbers to reflect more complete information.

However, it doesn’t end there. On top of these revisions, the BEA takes another pass at the GDP statistics once a year, usually in July, when it further refines the numbers.

MARKET IMPACT

To foreign investors, a strong American economy is viewed more favorably than a weak one. Robust economic activity in the U.S. spurs corporate profits and firms up interest rates; thus, foreign investors see opportunities to make money in the stock market and from higher-yielding Treasury bills and bonds. All this will increase the demand for dollars. If the Federal Reserve moves quickly to preempt inflation by driving up short-term rates, odds are it would also lead to an appreciation of the dollar because of the perception that the U.S. central bank is ahead of the curve in containing price pressures.

However, if inflation accelerates and stays at a high level, it would lower U.S. competitiveness in the world and worsen the country’s foreign trade deficit, a scenario that can make U.S. far less appealing.