posted in: Financial Security

A Two-Minute Economics Course

With the economy being a hot topic these days, being familiar with some basic facts about the U.S. economy may prove to be helpful to get a better grasp on what’s happening, and what may happen in the future.

Gross Domestic Product (GDP) – Measuring Overall Growth

Every quarter, the U.S. Commerce Department estimates the total value of the goods and services produced in the United States during the past three months. You should focus on the amount by which the GDP has changed, not the number itself. The change in GDP measures the rate of overall economic growth. Slow growth can mean companies’ profits are shrinking, which means that stock prices may decline, too. A drop in the GDP for two quarters in a row indicates the economy could be in a recession. When the GDP is growing, companies are doing well and usually stocks are, too.

Interest Rate Changes – Pushing Bond and Stock Values

The number to watch is the ten-year Treasury yield—the interest on newly issued U.S. Treasury bonds with a ten-year maturity. The bond market sets the yield, not the government.

Changes in interest rates affect bond values. Usually, values drop when interest rates rise, and values rise when rates fall. Bonds have a fixed interest rate, so when newly issued bonds offer a higher rate than existing bonds, it pushes the market value of the previously issued bonds down so that their actual return is in line with the new issues.

Stocks also react to changes in interest rates. High rates increase companies’ borrowing costs, which lowers the companies’ earnings potential. Because stock values generally reflect earnings prospects, rising interest rates are generally bad for stocks, while falling rates are generally good.

Consumer Price Index (CPI) – Indicating the Inflation Rate

The U.S. Department of Labor calculates the monthly CPI by comparing the current prices of a set list of goods and services – housing, food, clothing, transportation, medical care, etc. – with prices during a base period. The change in the CPI is an important indicator of the rate of inflation. Stock prices often rise when inflation is low and fall when inflation increases.

Unemployment Rate – Signaling Future Inflation

The U.S. Department of Labor also tracks the percentage of U.S. workers who are unemployed. The monthly unemployment report can forecast future inflation. A low unemployment rate indicates a possibility that inflation will rise because workers’ increased spending power drives prices up. High unemployment means less consumer spending and, therefore, less pressure on prices.

Money Supply – An Indicator of Inflation and Spending Patterns

As its name implies, money supply is simply the amount of money that’s available to be spent. You will sometimes hear this number referred to by one of its subsets – M0, M1, M2, or M3. Most often, it’s the M2 figure that’s used. Like GDP, it’s the change in money supply that should get the closest scrutiny.

A dramatic increase in money supply can cause inflation since that suggests that the public has more money to spend. A dramatic decrease in money supply can indicate that a formerly hot economy is cooling down, perhaps even to the level of a recession.

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