Module 2- Case Economic Indicators BUS305 - Competitive Analysis and Business Cycles August 18, 2012

How is the Economy Doing? INTRODUCTION This case study examines the types of economic indicators used to monitor our nations economy and the relationship between them. Economic indicators provide vital clues to the economic well-being of our country as a whole. The consensus is that all citizens of a given country benefit from its increased economic performance. One of the key economic indicators is the Gross Domestic Product (GDP). There are three ways for economists to calculate the GDP. They are the product (or output) approach, the income approach, and the expenditure approach (Wikipedia, 2012). The most direct of the three is the product approach, which sums the outputs of every type of business to arrive at the total, so that, and its basic components will be the focus of this case study.

BODY What is the Difference between Intermediate Goods & Final Goods? Determining the difference between intermediate goods and final goods is a vital function in the accounting function of our government. Ergo, it is necessary to know the meaning of these terms and also the difference between them. Intermediate Goods All those products, which are used by manufacturers to make other goods, are known as intermediate goods. These products are not in demand for their own sake, but for their use in producing other goods. Raw materials and semi-finished goods are regarded as intermediate goods. For example, raw-cotton fiber used for the production of yarn is an intermediate good. Similarly, when the yarn is sold to the owner of a textile mill for production of cloth, the yarn is

How is the Economy Doing? an intermediate good. Thus, intermediate goods are those goods which are sold by one industry to another either for resale or for producing other goods. The value of intermediate goods is not taken into account while estimating the GDP. Final Goods: Final goods refer to the finished goods, which are sold in the market for consumption and investment purposes. These goods are produced for their own sake, because these are finished products, and do not undergo further processing. Final goods satisfy the wants of ultimate producers, or consumers, or both. The value of these goods constitutes our Gross Domestic Product (Suri, n.d.). Real GDP- a True Measure of a Nations Economic Well-Being? Real, or Constant GDP, is adjusted for changes in money value and is used to calculate the GDP growth rate, which indicates how much our country's production has increased (or decreased), compared to the previous year. That being said, Real GDP still is not a reliable direct indicator of a nations well-being for a myriad of reasons. Chief among those is the fact that there is no accounting for population growth. If a country's GDP doubles over a certain period, but its population triples, the increase in GDP may not mean that the standard of living increased for the country's residents; the average person in the country is producing less than they were before. GDP does not consider the value of non-monetary work and output, including caring labor in the home; it doesnt put a value on the natural environment, leisure time, or the quality of life; and aggregate Real GDP statistics say nothing about how the output of the economy is distributed across different groups in society (Stanford, 2008). Nor is Real GDP a true measure of a standard of living. Rather, it is a fair measure of a countrys overall economic activity. Real

How is the Economy Doing? GDP can increase while personal incomes fall, as happened to the U.S. during the recovery from the bursting of the tech bubble and the 9/11 attacks (Dickinson, 2011). Given These Limitations, Is Real GDP a Useful Statistic? Real GDP data provides an important and informative snapshot into the behavior and performance of the overall economy. Real GDP is one of the most comprehensive and closely watched economic statistics: It is used by the White House and Congress to prepare the Federal budget, by the Federal Reserve to formulate monetary policy, by Wall Street as an indicator of economic activity, and by the business community to prepare forecasts of economic performance that provide the basis for production, investment, and employment planning (Bureau of Economic Analysis, 2007). What type of expenditures does the government make? Collecting taxes and spending money are our government's most important power. According to Wikipedia, As of September 2001 the U.S. Congressional Budget Office reported that federal government spending for 2004 was projected to be $2.293 trillion, or slightly less than 20% of the GDP. Of that, $646.7 billion was for net interest, $486 billion for defense, $492 billion for Social Security, $473 billion for Medicare and Medicaid, $191 billion for various welfare programs, $136 billion for "retirement and disability" benefits, and $64 billion was projected to be spent elsewhere. There are two types of government spending discretionary and mandatory (McGann, 2012). Discretionary spending, which accounts for roughly one-third of all Federal spending, includes money for things like the Army, FBI, the Coast Guard, and highway projects. Congress explicitly determines how much to spend (or not spend) on these programs on an annual basis. Mandatory

How is the Economy Doing? spending accounts for two-thirds of all government spending. This kind of spending is authorized by permanent laws. It includes Insurance programs like Social Security, Medicare/Medicaid, Supplemental Nutrition Assistance Program, and federal retirement and disability programs that provide benefits to federal civilian employees, members of the military, and veterans programs through which individuals receive benefits based on their age, income, or other criteria. Spending levels in these areas are dictated by the number of people who sign up for these benefits, rather than by Congress (Wikipedia, 2012). The chart below reflects the various historical spending levels for government by function:

What is the difference between discretionary spending and transfer payments? Discretionary spending is spending on tangible goods and services. Transfer payments are made by governments to individuals or corporations without expectation of receiving either a physical product or a service in return. Examples include: --Payments to disabled people which allow them to survive despite having no way to earn an adequate income. --Payments "earned" or

How is the Economy Doing? expected via "social contract" such as Social Security payments. -- Payments which have the effect or dampening the impact of localized disasters. Disaster relief and similar payments are seen as a form of "fair" distribution of the harm from random events or simply because the public wants to achieve some form of fairness. --Payments to farmers and farming corporations to get them to NOT grow certain crops. --Payments made simply because a special interest group had the money and clout to influence legislation in their favor (Admin, 2011). Why have transfer payments increased so significantly in recent years? There are many factors that have contributed to the increase in transfer payments in recent years. The current administration has increased, through legislation, many welfare reforms supported wholly by transfer payments backed by freshly printed money, and has attempted to stimulate the economy with multiple transfer payment schemes instead of straight-forward purchases of goods and services. That, coupled with the ever-increasing number of baby boomers joining the ranks of retirees, continues to swell the government deficit by leaps and bounds (Koesterich, 2011). In a nutshell, the paradox is this: The US economy is driven largely by consumption roughly 70% of gross domestic product (GDP) comes from personal consumption. A large and growing percentage of that consumption is dependent on federal transfer payments direct government payments to individuals (everything from Social Security to unemployment insurance). Yet as the United States tries to get its deficit under control, these payments could be cut. That in turn could have a significant impact on disposable income and economic growth.

How is the Economy Doing? Look Carefully at the Business Cycles over the Last 50 Years See table below:

BUSINESS CYCLE REFERENCE DATES Peak Trough

DURATION IN MONTHS Contraction Peak to Trough -8 10 11 16 6 16 8 8 18 Expansion Previous trough to this peak -39 24 106 36 58 12 92 120 73 Cycle Trough from Previous Trough -47 34 117 52 64 28 100 128 91 Peak from Previous Peak --32 116 47 74 18 108 128 81

Quarterly dates are in parentheses

August 1957(III) April 1960(II) December 1969(IV) November 1973(IV) January 1980(I) July 1981(III) July 1990(III) March 2001(I) December 2007 (IV)

April 1958 (II) February 1961 (I) November 1970 (IV) March 1975 (I) July 1980 (III) November 1982 (IV) March 1991(I) November 2001 (IV) June 2009 (II)

(National Bureau of Economic Research, 2012) Judging by the cycles listed above, the U.S. has gone through some form of recession every few years for the last 50 years. The explanation of changes in overall economic activity is one of the main concerns of macroeconomics. The framework for explaining these variances is called Keynesian economics. Keynesian theory holds that monetary policy and fiscal policy can have a positive role to play in smoothing the bumps in the business cycle (Wikipedia, 2012). According to the following table, there have been at least eight boom periods followed by recessions in the last fifty years and each was surrounded by its own unique set of economic circumstances.

How is the Economy Doing? What is the Economic Outlook for the U.S. for the Next Five Years?

Name

Dates

Duration

Time since previous recession 3 yrs 3 mos

Characteristics The budget balance resulted in a change in budget surplus of 0.8% of GDP in 1957 to a budget deficit of 0.6% of GDP in 1958, and then to 2.6% of GDP in 1959. Federal Reserve raised interest rates in 1959. The government switched from deficit (or 2.6% in 1959) to surplus (of 0.1% in 1960). Began the second-longest period of growth in NBER history Mild 1969 recession followed a lengthy expansion, followed by inflation due to increased deficits. Fiscal tightening after Vietnam War and the Federal Reserve raising interest rates. A quadrupling of oil prices by OPEC The period was also marked by the 1973 oil crisis and the 19731974 stock market crash. Rising unemployment coinciding with rising inflation. Short recession in 1980, followed by a short period of growth and then a deep recession. Unemployment remained relatively elevated in between recessions. The recession began as the Federal Reserve raised interest rates dramatically to fight the inflation of the 1970s. The early '80s are sometimes referred to as a "double-dip" or "W-shaped" recession. The Iranian Revolution caused the 1979 energy crisis,forcing prices up. Tight monetary policy in the United States to control inflation led to another recession. After peacetime expansion of 80s, inflation increased & the Federal Reserve raised interest rates from 86 to 89. Some combination of 1990 oil price shock, the debt accumulation of the 80s, & consumer pessimism produced a brief recession.

Recession of 1958

Aug 1957 April 1958 Apr 1960 Feb 1961

8 mos

Recession 196061

10 mos

2 yrs

Recession of 1969 70

Dec 1969 Nov 1970 Nov 1973 Mar 1975

11 months

8 years 10 months

197375 recession

1 year 4 months

3 years

1980 recession

JanJuly 1980

6 months

4 years 10 months

Early 1980s recession

July 1981 Nov 1982

1 year 4 months

1 year

Early 1990s recession

July 1990 Mar 1991

8 months

7 years 8 mos

How is the Economy Doing? Time since previous recession

Name

Dates

Duration

Characteristics The 1990s were the longest period of growth in American history. The collapse of the speculative dot-com bubble, a fall in business outlays and investments, and the September 11th attacks, brought the decade of growth to an end. The recession was brief and shallow. The subprime mortgage crisis led to the collapse of the United States housing bubble. Falling housing-related assets contributed to a global financial crisis, even as oil and food prices soared. The crisis led to the failure or collapse of many of the United States' largest financial institutions: Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers and AIG, as well as a crisis in the automobile industry. The government responded with an unprecedented $700 billion bank bailout and $787 billion fiscal stimulus package. The National Bureau of Economic Research declared the end of this recession over a year after the end date. (Wikipedia, 2012)

Early 2000s recession

March 2001Nov 2001

8 months

10 years

Late2000s recession

Dec 2007 June 2009

1 year 6 months

6 years 1 month

CONCLUSION No one can predict the future with absolute certainty but many make educated projections. Longterm economic forecasts are issued by the government, financial analysts, and academics. While they are different and not all positive, there are nine critical economic measures that suggest the economy will significantly improve by 2017. These are housing prices, real income, inflation,

How is the Economy Doing? military spending, entitlements, unemployment, taxes, interest rates and the state of the U.S. deficit and debt. Housing prices will rise sharply. I believe that Congress and the Administration have finally joined the majority of economists who believe that if housing prices do not recover, the odds of a broader recovery are unlikely. There are approximately 11 million mortgages underwater. The government will develop a successful plan to help homeowners refinance their homes at very low interest rates. These same rates, coupled with lower unemployment, will allow more home purchases possible. Real income will rise by 10 percent. The Census Bureau reported recently that real income fell 2.3 percent in 2010, putting it 7.1 percent below its 1999 peak based on inflation-adjusted numbers (Wikipedia, 2012). This is partly due to unemployment and partly to the size of the labor force, which increased with the baby boom generation. Fortunately for workers and potential workers, baby boomers have begun to retire and most will be out of the workforce in the next 10 years. This will open up jobs for both the lowest paid groups in the economy minorities and people under age 24 and the middle-class workers who now compete for jobs with those older than they are. Inflation will be moderate. Inflation rates are some of the most difficult parts of the economy to forecast. Inflation can be imported as the costs of goods and services brought into the U.S. rise. Its also affected by monetary policy. And, its especially influenced by the prices that businesses have to pay to create final products. Energy prices have been among the most critical causes of inflation since oil moved to $140 a barrel in mid-2008. The Federal Reserve, however, has put into place policies that likely will keep inflation in check for the next several years. Oil prices have fallen by almost half from their 2008

How is the Economy Doing? peak, and slack demand from China will continue as that countrys PMI and GDP growth slow. Lack of demand for Chinas goods from the crippled EU markets will reduce their need for crude (McIntyre, 2011). Military spending will fall sharply. The federal government has faced huge expenditures over the past three years from the wars in Iraq and Afghanistan. The total cost of the war in Iraq, which will end as the last U.S. troops leave the country on December 31, is estimated to be above $800 billion. The Afghanistan war has cost over $450 billion. The latest CBO Budget and Economic Outlook released in August shows that defense spending will rise very slowly from $708 billion in 2012 to $714 billion in 2014 (McIntyre, 2011). A slow rise in inflation and Congresss apparent inclination to use military expenditures as a way to close the budget deficit will keep spending down. Entitlements will be cut. Mandatory spending is expected to rise from $2.1 trillion in 2012 to $3.1 trillion by 2020 if not curtailed. Spending for Social Security will grow at an average annual rate of almost 6 percent over the 2012 to 2021 period (McIntyre, 2011). The agency also forecasts that between 2013 and 2021, Medicare outlays will grow at an average annual rate of 6.3 percent, reaching $966 billion (4.1 percent of GDP) in 2021. These increases will be only partially offset by a drop in payments made for unemployment insurance, which should fall along with joblessness. Social Security/ Medicare are two of the keys to reducing the federal deficit and eventually the size of the national debt. Unemployment will drop to 6 percent. The CBO expected unemployment to drop to just above 5 percent by 2020, and there are several reasons that this is likely to be right. The first is that the U.S. labor force will have been reduced by baby boomer retirees by

How is the Economy Doing? then. The next is that a recovery in housing prices will spur consumer spending, which will in turn produce jobs. Government incentives to businesses to add employees will improve hiring. Programs of this kind are already being discussed as part of the jobs bill. They make economic sense because the Treasury gets tax receipts from those who are hired, which more than offsets the cost of tax credits to create jobs. Individual tax will remain modest. One of the benefits of cuts in entitlements and military spending is the ability of the government to keep taxes lower. The effects of this are aided by the recent consensus of both political parties to keep taxes low as a means of stimulating the economy. Americas corporations will most likely be targets of higher tax rates, which will ease the burden on individual taxpayers. Interest rates will stay low. The Federal Reserve has kept interest rates low as a means to stimulate the economy. Mortgage rates are consequently just above 3 percent very near an all-time low. Rates will stay down for the next two years or more as the Fed works to stop any increases. The reasons rates will remain low after that are based primarily on a need to keep GDP growth relatively high and to allow American businesses to remain competitive in a world in which most other major nations use rates as a means of stimulus. The recession we are currently pulling out of is still a slow climb. The U.S. will get back its AAA rating. It lost the rating from S&P because of political strife in Washington, concerns the U.S. could not control its deficit, the increase in its debt and the observation that the U.S. economy would not grow over the next two years. The CBO expects the annual deficit to fall from $1.3 trillion this year and nearly $1 trillion in 2010 to an average of $250 billion in the years from 2014 and 2020 (McIntyre, 2011).

How is the Economy Doing? References Suri, Sushil, n.d., Brief Notes on Intermediate Goods and Final Goods. Preservearticles.com/ Retrieved from: Brief notes on Intermediate goods and final goods "Measuring the Economy: A Primer on GDP and the National Income and Product Accounts" (PDF).September, 2007; Bureau of Economic Analysis. Retrieved from: http://www.bea.gov/national/pdf/nipa_primer.pdf Dickinson, Elizabeth. "GDP: a brief history". ForeignPolicy.com.January/ February 2011. Retrieved from: GDP: a brief history - By Elizabeth Dickinson | Foreign Policy Stanford, Jim, Finding and Interpreting GDP Statistics, Canadian Centre for Policy Alternatives, 2008. Retrieved from: http://www.economicsforeveryone.ca/files/uploads/How_To_GDP_Stats.pdf McGann, Chris, 2012, Types of Government Budgets, EHow Money. Retrieved from:Types of Government Budgets | eHow.com Wikipedia, 2012, Government Spending. Retrieved from: Government spending - Wikipedia, the free encyclopedia Admin, Government Budget Deficits are Largely Nondiscretionary: The Case of the Great Recession of 2007, New Economic Perspectives, Daily Archives, July 4, 2011. Retrieved from: http://neweconomicperspectives.org/2011/07/04 Koesterich, Russ, The Transfer Payment Paradox, iShares Blog, September 7, 2011. Retrieved from: http://isharesblog.com/favicon.ico National Bureau of Economic Research, US Business Cycle Expansions and Contractions, August, 16, 2012. Retrieved from: http://www.nber.org/cycles.html Wikipedia, List of Recessions in the United States, 2012. Retrieved from:http://en.wikipedia.org/wiki/List_of_recessions_in_the_United_States McIntyre, Douglas, A., Why the US economy will be booming by 2020, 24/7 Wallstreet.com, October 24, 2010. Retrieved from: http://www.msnbc.msn.com/id/45022308/ns/businesseye_on_the_economy/t/why-us-economy-will-be-booming/