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Tag: us economy

  • Commonly used macroeconomic terms that you should know

    Today, I explain some of the most widely used macroeconomic terms relating to a country’s economic performance. These are the terms we often read in the news, so we need to understand what they are and how they affect us. My list is not comprehensive, but I feel it is a good start. In my future posts on Economic Glossary, I will be explaining the meaning of some other important economic terms, so please stay tuned for that. For now, let me explain the ones that are coming to my mind as I type.

    Interest rate: It is the cost of borrowing money or the return we get from saving our money. By changing interest rates, the Fed (central bank) can influence economic growth. Low-interest rates encourage spending and investments and make the economy grow. On the other hand, rising interest makes loans more expensive and lowers investment. This reduces firms’ hiring, employment, and thus total demand in the economy and can lower both inflation and GDP growth.

    GDP: It measures the size of the economy. It is the market value of everything (final goods and services) produced in a country, whether it is made by its citizens and companies or by the rest of the world. Market value is how much we pay for something, such as the market price for that bread we eat or the plumbing service we get. The US GDP number is published every quarter to see its trend. Economists at the U.S. Bureau of Economic Analysis estimate GDP by using a lot of data gathered by other federal agencies and private data collectors. As of Q1, 2022, the US Real GDP was $19.7 trillion. The US is the number one economy in the world when measured by real GDP.

    GDP Per capita is the GDP divided by the total population. It shows the standard of living of its people and this number is published once a year. Real GDP is the GDP at constant price or base year prices. This measure removes the effect of rising prices on GDP. GDP growth rate is a % measure that calculates real GDP growth as compared to the previous quarter or the previous year. This could be a positive or negative % depending on an increase or decrease in real GDP. To know more about US GDP growth, click here.

    Recession: A recession is a significant fall in the economic activity of an economy. It is mostly seen as a decrease in income and employment. During a recession, there is a significant drop in consumer spending. Some businesses can go bankrupt, people out of school don’t find good jobs and people might lose their homes when housing prices fall. If you want the exact definition of recession or expansion in the US, here’s a good source https://www.nber.org/business-cycle-dating-procedure-frequently-asked-questions

    Inflation: The inflation rate is a sustained rise in the average price level during a specified period, usually a month or a year. It is calculated as a % increase or decrease in prices from the previous period. Inflation exists when prices increase but our purchasing power reduces over some time. As seen in my post here, demand, supply, and future expectations about inflation affect inflation. 

    US Government and the Fed both measure and publish inflation numbers every month. They use CPI and PCE respectively for measuring inflation. Sometimes, the CPI can give us misleading information because it includes food and oil/gas prices. These numbers are usually more volatile. The core inflation rate excludes food and energy prices and thus is a better measure of the inflation rate. The Personal Consumption Expenditures price index is another measure of inflation. It includes more business goods and services than the CPI. For example, health care services paid for by health insurance companies are part of PCE and not CPI.

    Unemployment rate. Every country sets a target unemployment rate that it seeks to achieve. In most advanced economies it is a lower % compared to developing economies. In the US, The BLS publishes this % every month. The Fed aims to keep the unemployment rate around 4%. The unemployment rate represents the number of unemployed people as a percentage of the labor force. People in the labor force include people 16 years of age and older, who are either employed (have a job) or unemployed (those who have looked for a job in the past 4 weeks but couldn’t get one).

    As of June 2022, the unemployment rate in the US was 3.6%. The total number of unemployed persons was 5.9 million.

    Monetary policy or the Fed: Federal Reserve is the central bank of the U.S. The Fed performs many important functions such as supervising the nation’s commercial banks, conducting monetary policy and providing financial services to the U.S. government. It also promotes the financial system’s stability by taking measures to prevent crises like recession and bank failures.

    The Fed is not just one bank but consists of 3 main components.

    1. Seven Board of governors guide the entire monetary policy and set the discount rates for member banks
    2. 12 regional federal reserve banks are located in Atlanta, Boston, Chicago, Cleveland, Dallas, Kansas City, Minneapolis, New York, Philadelphia, Richmond, St, Louis, and San Francisco.
    3. FOMC, the Federal open market committee. It meets eight times a year and makes decisions that help promote the health of the U.S. economy and the stability of the U.S. financial system.   

    The Fed is an independent entity and is not affected by U.S. politics. Congress has given Fed a dual mandate of stable inflation and maximum employment. The Fed tries to keep prices stable with a long-term 2% inflation target and also promotes maximum employment. Please see my detailed post on how Fed in the US uses its monetary policy tools to keep inflation in the target range.

    Fiscal policy : Fiscal policy is the term used to describe the spending and taxation decisions of a government that can influence an economy. For example, the government can lower taxes and raise spending to boost the economy when needed. Governments often spend on infrastructure projects to create jobs and grow income to take the economy out of a recession.

    Similarly, the Fed increases business investment and spending by lowering interest rates. In a boom situation, when the economy is overheating with high inflation and very low unemployment, they do the opposite. The government reduces its spending and raises taxes. Alternatively or in addition, the Fed raises the federal funds rate which in turn increases all the other interest rates in an economy and thereby puts a break on overall economic activity. Thus, either fiscal or monetary policy or both can be used to expand or contract the economy.

    If you like my posts or think I can do better, please provide your feedback in the comment section below. I will be happy to research and write about any topics you might be interested in learning more about. Thank you!

  • GDP in the US decreased in the first three months of 2022

    You might have heard in the news might have heard that the US economy has contracted in the first quarter of 2022. When we talk about economic contraction or expansion, we look at the % change in the most widely used statistic to measure the overall economic health of a country, also known as the GDP. Many were surprised by this decline, and it’s said as the worst quarter since the pandemic started in March 2020. To know more about what GDP is, please click here.

    The official source of publishing GDP numbers in the US is the Bureau of Economic Analysis. In their April 28, 2022 press release, they projected an annual 1.4% decline in the real Gross Domestic Product of Q1 2022 vs a growth projection of 6.9% in Q4 2021.  If you want to see the details about the calculation, data, and assumptions, you can check this page here. https://www.bea.gov/data/gdp/gross-domestic-product

    What were the reasons for this decline?

    The main reason that made the GDP growth negative was the trade deficit, meaning imports were far more than our exports, as US domestic supply couldn’t keep up with the domestic demand.  In addition to the trade deficit, the GDP was also deflated by the omicron variant of COVID that shut down some businesses, and the government-funded pandemic relief to businesses and households decreased or stopped altogether by the first quarter of 2022.

    Should we worry about this slowdown?

    Despite the projection, economists are saying that there is no reason to panic yet because this GDP decline happened due to the net export component. In the chart below, data collected from BEA shows the percent shares of each of the four main contributors to the US GDP in the 2022 Q1.

    The two major contributors to the US GDP have been consumption and investment, and both remained strong. Consumption, which is the most important driver of the US economy (contributing to almost 70%) increased during the first quarter at a rate of 2.7% annually, compared to 2.5% during the fourth quarter of 2021. Similarly, the business investment such as capital expenditure on factories, equipment, software, etc. remained robust and hence should increase productivity for the remainder of 2022. Firms’ investment had grown at a rate of 9.2% in the first quarter of 2022 which is a significant increase from the 2.9% increase in the last quarter of 2021.

    In summary, even though the GDP first quarter fell, it is not indicating a recession coming. A recession is defined as a fall in GDP in two successive quarters. And we may only hope for a better future and some happy news in the economy.

  • What is causing the prices to rise the world over? Understanding inflation and its causes

    The most talked-about topic affecting everyone for now almost a year is inflation. Your money loses its purchasing power, you need more money to buy the same amount of goods and services you purchase or use. If you are hiding a lot of money under your mattress or in a safe place at home, trust me it’s a bad idea. You will only be able to buy fewer items with that in the future than now.

    The easiest way to define inflation to a layman is the sustained increase in the average prices of a basket of goods and services that we buy over a specific period. So, when there is inflation, the cost of living goes up. This becomes a real problem if your income doesn’t rise as quickly as inflation, then with your current income, you will only be able to buy less same stuff than before.

    The inflation rate is expressed as a percent change from the previous period. Below is the actual inflation rate in the US in the last 6 years. So if the annual inflation is 6%, it means on average, prices have risen 6% from the last year. As you can see, the inflation slope became steeper in 2020, after the pandemic hit the global economy.

    So, what causes inflation?

    This can happen in two ways: either through demand-pull factors or through cost-push factors.

    The quantity theory of money explains inflation caused by demand-pull factors.

    Demand-pull inflation

    This occurs when people have too much money and they want to buy more, whereas there is not enough supply to meet that demand. Or in other words, too much money is chasing too few goods. This usually happens when the economy is at (or very close to) full employment/full capacity. By full employment, we mean people who are looking for jobs can find one. Also, in this situation, the country’s GDP grows at a rate faster than its long-run trend rate. This happens when there is too much money in circulation. If the bank interest rates are too low, people, both households and businesses can borrow easily and as a result, can buy more goods and services than what the firms can supply. We call this phenomenon “too much money chasing too fewer goods”. Producers increase prices and profit because they can’t increase supply in the short run.

    Using the demand and supply curves, I explain this idea. You see that the demand curve always slopes downwards, meaning people always want to buy more items at a lower price, Also, note that the supply curve faces upward, which means the firms producing those goods would like to supply more at higher prices, With the same assumption that is everything else staying the same. Equilibrium price and quantity are established at P and Q where the supply and the demand curve meet. We call them P and Q.

    To explain this graphically, let’s look at the demand and supply model. On y axis, we denote the general price level, since inflation reflects general price level rise. On x asis we will show the real quantity of goods and services or real GDP. In the graph below, demand will be aggregate demand as this is represents demand from the whole economy. This demand is also downward sloping curve, as the demand for any normal item will be. It shows people overall demand lower quantities when the prices are high and demand more quantities when the prices are low. With the same assumption that nothing else is affecting the demand and everything else stays constant. The aggregate supply curve always is upward sloping meaning producers are willing to supply more at higher prices, so they can get more profits and vice versa. With the assumption that everything else is staying the same, the price level and quantity are set where aggregate demand meets aggregate supply at e. This is the price level consumers are willing to pay and producers are willing to accept and is denoted by P. And the corresponding quantity supplied and demanded is denoted by real production of goods and services or real GDP at Q. Economist call this equilibrium price level and quantity.

    If there is excess money in circulation in the economy, people can afford to buy more, so for each price level, there is an increased demand. Or in other words, too much money is chasing fewer goods.

    In our graph, you will see the aggregate demand shifting to the right or upwards. Now we get the new equilibrium e1, where the new demand and supply meet, and you can see that the new price and the quantity both have increased to P1 and Q1. This happens in the short run when producers don’t increase the supply of goods and services but instead, charge more prices because of increased demand.

    Over time when producers can increase their production, the supply will be increased. In the graph below, this will mean the supply curve shifts to the right. So we can see at the new equilibrium, the prices will fall back. How much the prices fall, will depend on how much adjustment (increase) in supply is made in the long run. If the supply is adjusted enough to meet the increasing demand, then the prices will back to level P and the quantity demanded and supplied will be even higher, as shown at Q2. And the increase in the general price level is controlled.

    Cost-push inflation

    When the supply of the good is reduced due to an increase in the price of inputs in making that good or service. Supply shocks can cause cost-push inflation. Supply can fall due to a variety of reasons, such as if the cost of inputs for production goes up or if there is a natural calamity. Most recently after the pandemic, lockdown jams in major ports have contributed to a slowdown in the supply of a lot of items.

    In the graph above, supply shock has pushed the price up to P1, and Quantity is reduced to Q1.

    How to calculate the inflation rate?

    Inflation is expressed as a % change in the price level of a market basket of goods and services over a period. To understand how inflation is calculated, let’s start with a very simple economy, where people only bought and consumed 3 items – bread, internet, clothing, and a house.  You spend 30% of your yearly income on bread, 10% on clothing, 10% on the internet and 50% on renting an apartment. Then let’s assume the price of bread in year 1 is $2 and the price of internet is $45, price of clothing is $10, and rent is $25000. The price of bread in the year 2022 goes up to $2.5, price of internet becomes $60, price of clothing increases to $15 and rent in year 2 is $30000. We also, in the table below, list the proportion of income or weight they spend on all these items. The sum of these weights needs to add to 100%.

    Inflation from year 1 to year 2 is calculated as (CPI2 – CPI1)/ CPI1 * 100 where CPI1 is the price level in year 1 and CPI2 is the price level in year 2. CPI is a weighted average price of many day-to-day goods and services that a typical American person living in a city buys at a particular time. Don’t be frightened by the term “weighted average”. Weight here refers to the importance of spending on a particular item compared to total expenditure. It simply means more weight is given to goods and services where you spend more money of your income. This could be because you buy that thing more often like, daily or you spend a lot of money buying it.

    If we change the weight of some things from table 1, even with the same absolute increase in price, the inflation % will change. As you can see in table 2, it became 20.02%.

    If the change in prices is more compared to that from table 1, even with the same % of weight, the inflation % will be greater.

    BLS calculates and publishes inflation in the US

    However, our consumption is not just restricted to these four items. In fact, a typical American urban consumer consumes a wide variety of goods, known as the market basket of goods.

    In the US, the Bureau of Labor Statistics calculates something called the CPI (consumer price index). To collect the monthly price data, BLS-trained representatives make personal visits, phone calls, and get online surveys to collect data on what goods and services American people are buying.

    The price and weight info are essentially based on a survey of people of what proportion of their income people spend on a given good or service. BLS tries to calculate the prices of the same basket of goods and services. Now, here some people will argue that what if people don’t consume the same things after some years? That is a subject of further investigation, but the general idea is that the BLS tries to calculate the prices of the same goods and services consumed by the average person over a period for which it is calculating the inflation rate.

    If you are interested, you can check the detailed report here with relative weights and price changes by category. https://www.bls.gov/news.release/pdf/cpi.pdf

    Since CPI is a sample of retail prices and does not cover the complete universe of all prices, it is subject to some errors. However, that sampling error is not statistically significant to change the calculation by a lot. You will have to get into statistics class to understand the more technical aspects of what is considered a significant error or not, but for now, you can understand the error possibility is very small, so it is a reliable indicator of how the prices are behaving in general.

    But when do we need to worry about inflation?

    Well, some inflation is not bad and is considered healthy for the economy. Since our salary/wages have also increased over time and in most cases, some general rise in price level doesn’t hurt our purchasing power.

    The BLS calculates this measure at 1-month, 3 months, 6 months, and 1-year intervals, and publishes that data. Over the last 40 years, we have seen this inflation % on average staying close to 2% annually. That means the same basket of items that you buy is 2% more expensive from 1 year to the next. The goal of monetary policy is to keep the inflation number close to this target-rate.

    But in some countries like Zimbabwe and Venezuela, the prices had risen to a level making it very difficult for people to hold on to their currency. That situation where general prices rise at a rate of 50% per month is called hyperinflation. People know that they won’t be able to buy the same set of goods with that amount of money, even the very next day, so they demand more wages to cope with it. This, in turn, causes firms to pass this burden by increasing the prices of goods and services they provide. This, in turn, causes an increased demand for higher wages and the spiral continues. This is called the wage-price spiral. This can cause a severe crisis in any country.

    To know more about how the Fed uses monetary policy to control inflation, click here.

  • Global economy will slow down in 2022 and 2023. What policy measures the governments should take to get back to growth trajectory?

    IMF projects lower global GDP growth of 3.6% for the next two years

    IMF’s World Economic Outlook report published on April 19, 2022 has predicted a drop in the GDP growth of the world economies in the years 2022 and 2023 to 3.6%. This downward revision is from their previous estimate of 6.1%, largely because of the war in Ukraine. IMF publishes this report twice every year.

    Below is the chart from IMF showing these growth projections by region. These projections are for real GDP growth and not nominal GDP growth. As changes in real GDP are the most popular indicator of a country’s overall economic condition. If you want to know more about the US GDP and its components, please click here.

    Countries, like the United States, the EU, Japan, the UK, Canada, and other advanced countries are projected to grow on an average of 3.3% in 2022 and only 2.4% in 2023.

    The emerging market and developing countries such as India are projected to grow at 8.2% in 2022 and 6.9% in 2023. Whereas because of the lockdown in Shanghai, China, the projected growth is slightly lower at 4.4% in 2022 and it is expected to be 5.1% in 2023, as the lockdowns are eased.

    As expected, there is a severe double-digit drop (-35%) in GDP projection for Ukraine in 2022. They also project a contraction for Russia due to sanctions and European countries’ decisions to reduce energy imports. The war has also severely impacted emerging and developing Europe, which shares proximity to the war area with an expected fall of 2.9% in their real GDP in 2022. There is a hope of some recovery in 2023 with GDP growth returning to 1.3%. Russia will see a GDP growth of -8.5% in 2022 and -2.3% in 2023.

    The two charts below show the GDP growth comparison in some major countries of the world after the start of the global pandemic. The first chart shows the performance in the years 2020 and 21.

    The second chart shows the projections by IMF for the years 2022 and 2023.

    Sadly, the war just doesn’t affect the countries directly involved, its economic costs and implications are widespread. Through commodity markets, trade, and to some extent financial interlinkages of the countries, the war can indirectly affect so many more countries.

    Globally we are seeing rise in fuel and food prices since late 2021. The fear of War is aggravating high inflation problem even further. Unfortunately, the world’s poor population, particularly in low-income countries is getting the most impacted by this. To know more about inflation, please click here.

    Many leading economists propose mutual efforts by countries to respond to the war crisis and prevent further economic fragmentation. At the same time, it is important to manage the debt problem, tackle climate change and end the pandemic to bring back economic growth.

    Fighting inflation without slowing down the economy is the toughest challenge many central banks are facing currently. To know more about monetary policy and the role of a central bank, in controlling inflation, please click here.

  • What is economics and why should I learn it?

    A lot of people think economics is all about money, banks, complicated graphs, and mathematical modeling, but truly speaking it is much more interesting than that.

    So, what exactly is Economics?

    Economics is a study of human behavior, understanding the choices people make with their limited resources. By resources, we mean the tools needed to produce goods and services for humans consumption for a comfortable life. These resources are usually classified into 1)land, 2)labor, 3)capital such as tools and machinery, 4)human capital or entrepreneurship, and 5)our precious time.

    We don’t usually have an infinite amount of these resources, so how do we allocate the limited resources to make us better off and happier? In short, Economics deals with our struggle to achieve happiness in a world full of constraints and limitations.

    The word Economics comes from the Greek word oikonomia, which means household management. It starts with an individual making a tradeoff, choosing the best option that satisfies their wants, and forgoing the other best alternative use of their resources. From individual households, it moves to businesses, deciding what and how much to produce and sell. And lastly, government and the central bank decide when and how to intervene to ensure maximum happiness for its citizens.

    We are making choices every single day. For example, if you are reading this, you have chosen to gain some knowledge vs. maybe, watching a TV Show or doing something else.

    While reading this, you think you are making the best use of your time. (or at least I hope you do 😉 In short, you apply economics every minute (even when you don’t know it).

    What does the field of Economics cover?

    As you learn Economics, you can find answers to some fascinating questions such as:

    • How the price of anything is set?
    • How do we measure a country’s prosperity?
    • Why are some countries rich, while others are still poor?
    • What is inflation?
    • How do we understand business cycles?
    • What tools do the central bank and government use when the economy is facing inflation or a recession?
    • Is international trade a good thing?
    • And is reading this article even worth my time?

    Trust me, the list is endless. There is a wide variety of areas that economics can cover. Economists try to solve many of these problems our world is facing today by simply understanding human behavior and the choices people make. I might have used the word choice a lot here, but hope you got the idea?

    You will understand our rapidly evolving complex economies and how the economic fundamentals can still explain the changes.

    You can apply Economics in your day-to-day life, such as while analyzing the cost and benefits of a particular decision you are going to make and managing your finances.

    Similarly, you will also understand how economic principles apply to the businesses around us from a small local donut shop to a big company like Apple.

    Understanding economics will enable you to evaluate the feasibility of promises made by politicians to get your vote.

    Believe it or not, Economics can also help us understand the best strategy to deal with environmental issues, such as global warming and pollution.

    Last but not least, since Economics is based on human behavior, there can be more than one view on any economic issue. It’s not an absolute science and many times economists differ on how a certain situation should be handled.

    When you study Economics, you can acquire the necessary skills to argue why a specific viewpoint makes more sense to you.

    Some key principles of economics are:

    • Everything has an opportunity cost and experiences diminishing returns.
    • People are rational (for the most part) and act in their self-interest (even charity is considered self-interest since it gives you some happiness).
    • Supply and demand interact through an invisible hand.
    • Comparative advantage fosters trade.
    • People think on the margin.

    I will explain the above points in detail in my other posts. We will also dig into the two main subdivisions of economics: macroeconomics and microeconomics. We are only getting started!