Economics concepts and applications

Economic indicators are used to measure the financial health of the economy. There are many methods and tools for measuring the economy and every economist has his favorite method. The health of the economy is measured by tracking certain indicators. Different economists use these indicators in various combinations. Some economists place more or less weight on different ones in making their predictions about which direction the economy will go. It is important to note the differences in measurement when assessing the opinions of popular economists of today.

This paper will be primarily concerned with the indicators, which would indicate whether we are currently in an inflationary economy or a deflationary economy. A recession occurs when real GDP declines for two successive quarters. However, the National Bureau of Economic Research (NBER) officially defines a recession as a "significant decline in activity spread across the economy, lasting more than a few months." That becomes a depression when the GDP decline is protracted (Clifford, 2001). This difference in definition is why one hears news broadcasters fail to agree as to whether we are in a recession or not. It may meet one definition, but not the other.

According to Forbes Magazine, February 28, 2002, the GDP has grown consistently throughout 2001, though sometimes this growth may have been slow. The only time when the GDP decreased was third quarter 2001 when it dropped 1.3%. It quickly recovered and has shown strong growth since that time (Morrison, 2002). The drop in the GDP in the third quarter of 2001 may have been due to the terrorist attacks on the World Trade Tower, which shook consumer confidence in certain sectors, especially the transportation industry.

At the close of the day April 22, 2002 the inflation rate was 1.32, the GDP growth was 1.70, the Unemployment rate was 5.70, gold was at 303.70 per troy ounce and The Prime lending rate was 4.75. These numbers are according to the Financial Forecast Center (2001). Unemployment way up.1 from last quarter, but was down from 5.8 at the same time last year. This is relatively steady.

Now let us examine the various indicators that help to determine the rate of inflation or deflation. The Consumer Price Index is the most visible measure of inflation. It measures the cost of buying a fixed "market basket" of goods and services over time. Since it assumes that consumers maintain identical buying patterns even if prices rise, it tends to overstate inflation.

The Core CPI excludes the purchase of energy and food, making it a less volatile. The Employment Cost Index measures change in cost of labor. This is a key inflation indicator, as prices will rise as the cost to producer's increases.

The Gross Domestic Product (GDP) measures the total output of goods and services in the U.S. Many economists believe that a real GDP growth rate much higher than 2.5% may lead to inflation, although this wasn't the case in the late '90s. The Producer Price Index measures whether producers are getting more or less for their goods, indicating inflation at the wholesale level, which in turn means consumers will pay higher prices.

The Leading Economic Indicators (LEI) area weighted index of 10 indicators (the S&P 500, housing permits, and others). Three consecutive months of decline might signal a recession. These are the factors that the government officials use to determine economic policy in the United States and economists use to make their predictions. When unemployment is low, leaders focus on the labor market including the employment cost index and workers' average hourly earnings. When the economy seems weaker, they focus on potential growth areas, such as durable goods orders, consumer confidence, and the yield curve (Clifford, 2001).

The current expansion has challenged conventional wisdom about the business cycle and the relationship of strong growth and low unemployment to inflation. As a result, many economic models built during previous cycles are being revised to better make predictions in the current cycle. Economists use these models to predict the general direction of the economy and to try to guess what actions the Federal Government will make to try to curb or boost the economy via their policy decisions.

One model currently back on Wall Street's drawing board is the Taylor Rule, which we first wrote about in September 1997. Introduced by Stanford professor John Taylor, the rule attempts to infer an appropriate Federal-funds rate from current economic conditions. It starts with a real rate, without adjustment for inflation, that represents a neutral monetary policy. To this "equilibrium" rate is added the current inflation rate plus two equally weighted factors: the output gap and the inflation gap. The implication is that if the economy grows more quickly or prices rise more rapidly than the Federal Reserve is comfortable with, it will raise the funds rate (Hester 1999).

Economists compare the dip in the economy of third quarter last year to several other important periods in American history. These are the Cuban Missile Crisis, the Gulf War, the World Trade Center bombing and the Oklahoma City bombing. Looking at the market performance one-day, one-month, three-months and six-months after each event, the Gulf incident is the one that most closely matches the market performance since Sept. 11 (Canto, 2002).

In an article for American City Business Journals, Todd Buchholz, a former economic advisor to President George H.W. Bush, indicates that new home sales have prevented a deep recession from occurring. He states that lower interest rates are now making it possible for people who previously could not afford a home to purchase one. He says that this is especially true among minority buyers (Schroeder, 2002). This is an example of one segment of the market having a tremendous effect on the economy as a whole. Some blame the transportation sector for the drop in third quarter of 2001.