Issues

The Economy: Growth, Recessions and Prices

Four numbers dominate general economic coverage: output, unemployment, prices and the policy interest rate. Each is quoted constantly and each is more slippery than the coverage has room to say. This primer sets out what they measure, how they are built, and which of the arguments about them are real disagreements rather than misunderstandings.

Gross domestic product: what it counts

Gross domestic product is the market value of the final goods and services produced within a country over a period. Three things in that sentence do most of the work.

Market value means that anything not transacted at a price is largely invisible. Unpaid household work, volunteering and care are excluded — not because they lack value but because there is no price to record. Final means intermediate goods are netted out, so the steel in a car is not counted twice. Produced means GDP is a flow over a period, not a stock at a moment: it is not a measure of wealth, and a country can have a large accumulated stock of assets and weak current output, or the reverse.

GDP also arrives in two forms that are routinely confused. Nominal GDP is measured at current prices; real GDP strips out price change so that only quantity movements remain. Almost every growth figure quoted in the news is real, and almost every level figure quoted in a comparison is nominal. Mixing them produces nonsense. In the United States the estimates are published by the Bureau of Economic Analysis, which releases each quarter three times as more source data arrives; the first estimate is an educated approximation and the revisions between the first and third are frequently larger than the change the headline described.

None of this makes GDP a bad statistic. It makes it a specific one. It measures the scale of market production and does that well. It was never designed to measure welfare, sustainability or distribution, and the people who built it said so at the time.

Recessions: dated, not calculated

The familiar rule of thumb — two consecutive quarters of falling real GDP — is a rule of thumb, not a definition. In the United States, business-cycle turning points are determined after the fact by a committee at the National Bureau of Economic Research, which looks at a spread of indicators including employment, real income, industrial production and sales, and asks whether there has been a significant, broad-based and sustained decline in activity.

Two consequences follow. First, a recession can be declared without the two-quarter rule being satisfied, and the two-quarter rule can be satisfied without a recession being declared. Second, the announcement is retrospective — often by a year or more — so at the moment a downturn is most newsworthy nobody can yet say authoritatively whether it is one. Coverage that says "the economy entered recession" in the present tense is making a forecast, however it is phrased.

Inflation: a basket, not a price

An inflation rate is the change in the cost of a fixed basket of goods and services, weighted by how much of each a typical household buys. The construction has consequences that come up constantly.

• Your inflation is not the inflation. The index describes a statistical average household. If you spend far more than average on rent, fuel or tuition, your experienced rate will differ, sometimes by several percentage points.
• The basket has to change, and changing it is hard. Goods improve, disappear and get substituted. Statistical agencies adjust for quality change so that a better product at the same price registers as a price fall — a defensible procedure that reasonable economists argue about.
• "Core" is not a trick. Excluding food and energy is not an attempt to hide price rises; those two components are so volatile that including them makes it harder to see the underlying trend. Both measures are published, and both matter.
• A falling inflation rate is not falling prices. Disinflation means prices are rising more slowly. Deflation — an actual fall in the level — is a different and rarer condition with its own problems.

Interest rates and what a central bank controls

A central bank sets a very short-term policy rate and influences expectations about where that rate will go. It does not set mortgage rates, business lending rates or bond yields, all of which are determined in markets that respond to the policy rate along with growth expectations, inflation expectations and risk. This is why a rate cut can coincide with mortgage rates rising: the market has re-priced something else at the same time.

Monetary policy also works with a long and variable lag — the standard estimate runs to several quarters — which means the effect being reported this month is the consequence of a decision taken some time ago. The Federal Reserve's education programme sets out the transmission mechanism accessibly, and the St. Louis Fed's teaching resources are unusually good on the difference between what the central bank chooses and what the market decides.

What is genuinely disputed

Beyond the definitions, there are real arguments, and it is worth knowing which is which. How much slack an economy can run before inflation accelerates; how strongly public borrowing crowds out private investment; how much of a given inflation episode is demand, supply or expectations; how quickly wages adjust — these are open questions where competent economists reach different answers from the same data. Coverage that presents any of them as settled is compressing a live debate.

Where to look next

For how the employment side of this picture is measured, see work and wages and the longer report on how the jobs numbers are built. For the government's side of the ledger, see taxes and public finance. For the reporting mechanics behind all of it, see The Balance Sheet.