U.S. Economic Assessment: GDP, CPI, and Stability

Introduction: Short-Run Fluctuations and Long-Run Stability

The U.S. economy has been relatively stable for the past several years, with unemployment slowly declining, GDP growth modest but consistent, interest rates held low for an extended period, and inflation largely kept in check. Short-run fluctuations have been just that — short-run events that do not appear to have significantly impacted long-run economic policy or the overall direction of the U.S. economy.

In basic macroeconomic theory, short-run events should not have much significant impact on long-run economic outcomes. In the short run, an increase in aggregate demand should reduce aggregate supply. The supply side will then increase production to meet the higher demand level. If the demand spike was short-lived, this will result in overproduction, and output will then need to be reduced again to work down the oversupply. If aggregate demand returns to its starting point, so too will aggregate supply. The disruption to the trend will be minor, and the trend will be restored within a few months, returning to the normal equilibrium level (Investopedia, 2016).

If the short-run shift in aggregate demand persists over the long run, then the production increase must also hold, raising aggregate supply to meet aggregate demand at the new equilibrium point. This will be reflected in macroeconomic figures as sustained growth.

The former type of fluctuation — where the change in aggregate demand is short-run — should not produce lasting impacts on the overall health of the economy. Inflation rates and unemployment are stickier than aggregate demand and even aggregate supply, so the response to a minor short-run change in aggregate demand should not amount to much in terms of long-run outcomes. Only when a change is either long-run in nature, or sufficiently large, should there be an expectation of lasting change in other macroeconomic indicators. In particular, because short-run changes are unlikely to influence factors such as interest rates, trade agreements, or large-scale shifts in major markets like housing, the impact should remain muted. Minor short-run events do not trigger changes in the major drivers of long-run macroeconomic change. The U.S. economy is well-adapted to absorbing short-run changes in aggregate demand or aggregate supply.

CPI vs. GDP Price Index

The Consumer Price Index (CPI) is one of the main measures of inflation in the U.S. economy. The CPI is used by the Federal Reserve to help guide its monetary policy, and this lends the CPI a certain degree of influence. The Fed targets a CPI of 2% over the long run. If the CPI runs significantly higher or lower for a prolonged period, the Fed is more likely to adjust interest rates. The Fed sees risks in both higher and lower inflation, and thus views 2% as a target, expecting any sustained deviation from that number to trigger a shift in interest rates or another monetary policy lever (Federal Reserve, 2015).

The Federal Open Market Committee (FOMC) uses a personal consumption index for prices — specifically CPI or core CPI — rather than the GDP price index. The GDP price index is more broad-based, encompassing business, government, and foreign spending in addition to consumer spending (BLS, 2016). The reason the FOMC focuses on consumer spending alone is that the Fed views its mandate as oriented toward American citizens and consumers. It evaluates inflation and unemployment through this lens, on the theory that government and business spending will ultimately be reflected in consumer spending anyway.

While the GDP price index is more comprehensive as a measure, it does not appear to play a direct role in FOMC decisions. GDP itself does matter, because the Fed wants to see healthy, sustained GDP growth and will adjust monetary policy to encourage it. Since the Fed already tracks GDP, using the CPI adds a different perspective. The GDP and the GDP price index are too similar to one another, and using GDP to measure economic growth alongside the GDP price index to measure inflation would create too much overlap, reducing the value of the GDP price index in conveying new information. Using CPI essentially solves that problem, because inflation and unemployment — the two consumer-oriented measures — are sufficiently distinct from each other as indicators of overall economic health.

Effects of Unemployment and Inflation on the Current Economy

Any discussion about the current state of the U.S. economy appropriately begins with the Great Recession, at the nadir of which unemployment topped 10%. The Federal Reserve has since worked to raise GDP growth and reduce unemployment, employing an aggressive approach to expansionary monetary policy. The unemployment rate reached approximately 5%, hovering around that level for about a year (BLS.gov, 2016). This is higher than the pre-recession level, but represents a reasonable position for post-recession America. The stability of this unemployment rate is also important, as it suggests a kind of "new normal" — a default condition the Fed should view as stable and not in need of additional stimulus, particularly given that the Fed has limited capacity to provide any further stimulus.

The current core CPI inflation rate registered at 0.2% (BLS.gov, 2016), indicating a very low rate of inflation. This month-over-month rate of change equates to a fairly low annual rate, within the range the Fed considers appropriate. Taken together with a stable unemployment rate, this suggests the U.S. economy is grinding along at fairly stable and reasonable levels, though within an environment of high stimulus. There is little room for additional expansionary monetary policy, and these figures provide little justification for contractionary monetary policy either.