One of the best ways to judge a country’s economy is by looking at the Gross Domestic Product (GDP). The GDP is the total value of everything produced in a country’s economy whether it is consumed within its borders or abroad.
The GDP metric is most often used to evaluate the growth of the economy. Consequently, it is compared to the previous quarter or the same quarter from previous years and measure as a percent of change. GDP is also used to compare economies in different countries to each other and identify which countries have growing economies.
The GDP may seem like an abstract concept, but it has realistic implications for average consumers. For one, individual investors can use GDP trends to influence where they allocate investment assets. For example, if an emerging foreign economy shows rapid GDP growth, investors may want to investigate investment opportunities in that country.
The Bureau of Economic Analysis (BEA) issues reports on Gross Domestic Product, and different sectors of the economy are evaluated. Looking at trends within economic sectors can also help investors decide where to put their money. For example, if GDP growth for manufacturing sectors is declining, you might want to shift your investments away from manufacturing companies.
The Federal Reserve uses GDP growth, among other things, as a metric to determine when to raise and lower interest rates. If the rate of GDP growth increases, the Fed might decide to raise interest rates to prevent inflation. When the Fed raises interest rates, rates on consumer loans like mortgages also increase. Consequently, consumers can track the GDP as a way of predicting when to lock in a rate on a loan. If you expect the Fed to raise interest rates, it would be wise to lock in a fixed lower interest rate on a mortgage, for example.
That is far from the case in the current economic environment, however. The GDP growth rate is slowing thanks to the recession. While the final report from the BEA is not out yet, the preliminary report indicates the fourth quarter of 2008 may have experienced the worst quarterly GDP decline since the 1982 recession (a decline of 6.1%). That’s on top of a .5% decline in Q3 of 2008. Yearly GDP growth percentages have trended down since 2004. The Fed has already cut interest rates to almost 0%, so there is not much further it can go.
The downward trend in GDP growth is both reflective and predictive of many elements in the economy. One of the more significant relationships is between GDP and unemployment. As production goes up, companies generate more revenue and can afford to hire more workers and pay larger salaries. On the other hand, when production goes down, companies must find ways to cut costs and that often leads to wage and job cuts.
Often there is a lag between when the GDP growth rate declines and how it is expressed in the market. Production may have slowed, but it can take time for the subsequent loss in revenue to affect workers. That means even if the GDP growth rate levels off, the affect on jobs may be felt for a while.