People talk about the economy these days, and they know that it’s different from the stock market. But what is “the economy” really about?
“One of the biggest misconceptions people have, is they think that how they’re doing, or how their neighborhood is doing, is how the whole country is doing,” according to Wealthbridge founder Tim Randle.
He added: “Because we have clients in a number of states, and a wide variety of industries, we’re able to see that the economy as a whole is often much bigger than what people think it is from just looking at their neighborhood.”
So what is the mythic “economy” that everyone is speaking about and how do we measure it to know if it’s doing well? The shortest answer is GDP, or gross domestic product.
The main measurement for the health of the United States economy is the total value of goods and services we produce (or GDP). This is tracked by the Commerce Department and released every quarter, then revised a few times as more information becomes available. Those revisions mean you may see several, potentially different, numbers reported.
So what about all of the other economic indicators you hear about on the news? And if GDP is a measure for the United States, how can we measure the global economy? Questions like those come up on a somewhat regular basis, so let’s go through a few of them.
Growth and recession
Throughout history, and particularly since the industrial revolution, the trend in economics has been toward growth. As the human population grows, so too do the goods and services we create. Advancements in trade and technology increase our productivity, and we expand production. This type of expansion happens in cycles, known as business cycles, and growth is often marked by pockets of shrinkage, known as a recession.
A recession occurs when GDP shrinks for a significant period. Historically, two consecutive quarters of GDP decline signal a recession, but lately, the National Bureau of Economic Research (the people who officially declare a recession) has shifted to a broader definition. Now, the NBER says:
A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.
A depression is an enhanced recession. There are no specific criteria that move a recession into depression territory, but experts look for markers like an economic decline of more than 10 percent or unemployment above 20 percent. (Both occurred during the Great Depression).
Economic indicators
While GDP is the main metric for measuring the economy, a number of other measurements provide insight.
The unemployment rate (the number of people who want to work but can’t find jobs) provides information about consumers and corporations alike. If people aren’t working, they’re likely receiving less income, and therefore spending less, reducing the demand for goods and services. It can also mean companies are laying off workers or that fewer companies are hiring, both of which can provide insight into the creation of goods and services.
“To me, unemployment is the most important metric,” said Randle. However, he notes that COVID-19’s effect on the jobs market is unlike anything we’ve ever seen. Still, he thinks that anyone wanting to get a better sense of how the economy is doing can watch for trends in unemployment. How are things changing over time? Are there more jobs being created, or less? Do the right people exist to fill those jobs?
Other indicators include indices that track manufacturing or retail sales. Economists might also look at how much money Americans are saving or the amount of debt consumers are taking on.
Some also look at the health of corporate America — since corporations not only produce goods and services, they also hire smaller businesses and provide employment. This is one reason the stock market and the economy are often referred to in tandem, since the former can provide insight into the health of corporate America. The catch — which tends to fuel “the stock market is not the economy” refrain — is that stock prices can be influenced by more factors than just the underlying health of the company.
“The connection between stocks and the economy doesn’t always make sense,” according to Randle. “When a company lays off workers, often the stock price goes up. That doesn’t make sense to a lot of people.”
This happens because cutting jobs means cutting costs, which can mean more profit for shareholders. For the economy, though, lost jobs are generally a negative.
“You can see how they’re roughly linked, but they don’t always go hand in hand,” said Randle.
The global economy
There is, technically, a world economy that refers to the economy of all of the humans on earth, determined by the international exchange of goods and services, as valued by different currencies. If that sounds complicated, it is.
As the production of goods and services becomes more global, and as trade becomes more constant, the economies of independent countries become more intertwined. Essentially, most people using the term global economy are using it to refer to economies across the globe.
A global recession occurs when multiple economies across the world experience the same type of slowdown. Because countries trade heavily with each other nowadays, this is more likely than not.
An example of how this works
This example may be able to help you better understand how the global economy works, and how economists might use economic measurements in the U.S.
A recession occurs in China: The country’s GDP shrinks, and they produce fewer goods, including the parts used to manufacture computers.
Now, US computer companies don’t have the parts they need to make computers. The number of computer goods produced by the US shrinks.
Perhaps these computer companies lay off employees, which could lead to a higher unemployment rate in the US. Laid off employees have less income to buy things, so demand for various goods and services may shrink as a result. Less demand may result in companies making fewer products, which could lower the US GDP, or cause our economy to contract. All of this triggered, in a sense, by a recession in China.
Keep in mind, there are tools the US has to try and prevent this type of economic contagion. And this example is just hypothetical to illustrate how interconnected world economies are today.