This blog may help you not avoid this topic if it comes up at a cocktail party, and you may become a little more comfortable with a concept typically wrapped in weird jargon.
People tend to throw around economic terms they may, or may not understand, especially in the business media. We’re approaching the end of a long-term business cycle, and in the coming months pundits and professionals will begin obsessing about GDP.
GDP is the value of everything produced in the United States in a year (other countries have GDPs too, but that’s a different cocktail party). They really do mean everything, from haircuts to cars to buildings, but nothing imported since it’s not produced in the US. This is a huge number, right now around $19,000,000,000,000 per year…that’s $19 trillion. Just calculating it is a massive undertaking, and there are all sorts of PhD level statistics involved!
One of the reasons GDP gets more attention on the downhill side of the business cycle is because when the economy is booming everyone is looking at stock market gains. As the economy begins to soften and the dreaded R word, recession, comes into play, all of a sudden GDP is relevant. But, what is it and how does it relate to a recession?
Typically, what we obsess about is the change to GDP since that’s how fast the economy is growing or shrinking. There is some math done on this number to remove the effects of inflation for an apples to apples comparison. So, this change in GDP with inflation removed is called Real GDP. For the last three months of 2018 this change was an annual rate of 2.6%. Now, let’s look at how this meets with the infamous R word.
The most commonly accepted definition of a recession is when the Real GDP number is negative for two quarters, or six months, in a row. A private, non-profit called the National Bureau of Economic Research makes the official call on dating a recession, and there are many other factors they look at, but if GDP is negative for two quarters, we’re probably in a recession.
The good news is that in many cases we can be headed out of recession by the time we even knew we were in one since GDP always looks backwards at what happened during the prior three months. The bad news: when we’re at this point nobody needs to look at GDP to know the economy is in rough shape because unemployment will be up, people will spend less, businesses will earn less, there will be defaults on loans…anyway, I’m sure you get the picture.
So where are we now? Over long periods of time the economy moves in waves, and as you can imagine we’re at the peak of a long period of expansion that came following the last recession. Like watching a wave in the ocean that seems to hang frozen in the air, it’s hard to tell when the wave will crest and tumble. In economic terms this would be the trough, contraction, or recession.
All of this is why I like to watch the GDP. There is a lot of information available on GDP; because, given it’s importance, there are a lot of people in the industry who get paid to forecast and predict changes over longer periods. Much like TV weatherpersons, many of these forecasts end up being wrong, but looking at the overall trend can be helpful.
If I’ve really captured your attention, one of my favorite places to look is here. This is the Atlanta Fed’s “GDPNOW” forecast, which is nice because they track the evolution of the estimates of the next quarter’s GDP number, and also provide a range of estimates from the financial industry.
I hope this blog helped you gain a better understanding of GDP and why people like me talk about it a lot, and if it comes up at a cocktail party please jump into that discussion!
As always, please reach out if you have questions about this, or any other aspect of your financial life!
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