5/4/22
With unexpectedly negative real GDP (Gross Domestic Product) data being released yesterday morning, we have tangible evidence of the negative economic effects of inflation, supply chain disruption, and the Russian invasion of Ukraine.
Today we’d like to look into what GDP actually is, and what components are involved in its calculation.
To put it simply, GDP is the value of everything produced within a country’s borders. By only considering what is produced within the country, it helps to avoid two countries double counting the same product. GDP is divided into four subcategories that include Personal Consumption, Business Investment, Government Spending, and Net Exports.
Personal Consumption makes up roughly two-thirds of U.S. GDP and is exactly as it sounds; it involves all the goods and services purchased. The goods involved in Personal Consumption include two types: durable and non-durable goods. Durable goods are goods that are meant to be a long-term investment and generally should last at least three years, like vehicles or home appliances. On the other hand, non-durable goods are much more temporary, such as food or fuel. Services are self-explanatory and include anything from financial services to healthcare.
Business Investment is the value of the purchases made to help to produce goods and services. Examples of these purchases manufacturing equipment and software created to assist in the creation of new goods and services. Business Investment also includes the construction of both residential and commercial real estate. Inventory levels are the last component of Business Investment, as companies will try their best to keep a healthy level of inventory on hand to meet consumer demand.
Government Spending involves all federal, state, and local spending. On the federal level, this includes anything from programs such as Social Security and Medicare to defense spending. State and local levels can include more targeted investment into local infrastructure and schools.
Net Exports include the net difference of the amount of goods and services imported into the U.S. versus the amount of goods and services exported from the U.S. to other nations. Unsurprisingly, the U.S. is far and away the largest net importer in the world, even when accounting for the number of luxury goods produced and exported from the U.S.
By combining these four subcategories, economists are able to determine the health of the U.S. economy. Historically, economists have preferred GDP growth to remain between 2-to-3%, as this rate of growth (in theory) allows for continuous economic growth without the threat of inflation or asset bubbles appearing. On the other hand, negative GDP growth implies that the economy is beginning to contract.
By definition, a recession occurs when GDP growth is negative for two consecutive quarters. With the knowledge of what goes into GDP, investors can strive to be better informed about what goes into measuring the health of the economy.
