Overview
Gross Domestic Product (GDP) is one of the most important measures of an economy. When economists refer to whether an economy is growing or not, in most cases they consider GDP. GDP measures the total value of all goods and services produced in an economy in a given period (typically one year). For those who are interested, here's a link to a video in which an economist from the Atlanta Fed explains GDP in a little more detail. In the US and most other countries, GDP is estimated quarterly. For example, the first quarter GDP (Jan-Mar) is initially reported in late April with revisions reported in late May and late June (similar timetables are used for the other quarters). GDP is measured in nominal as well as real terms (i.e., adjusted for inflation). Economic growth is calculated by determining the percent change in real GDP. When considering quarterly data, US economic growth is reported as SAAR (seasonally-adjusted annualized rate, more details below). The following chart shows the percent change in GDP for each year since 1929, the first year in which GDP data are available. Note that 2009 was the worst year since 1946 (when the economy shrank as WW2 ended and the US shifted to a peacetime economy). When was the worst year for economic growth? As you would expect, it was during the depths of the Great Depression in 1932 when the economy shrank by 12.9%. The most rapid growth took place at the beginning of WW2 (1942) when the economy grew by 18.9%. Did WW2 end the Great Depression? Click here to find out.
Growth for Each Quarter Compared to Previous Year
Here's a similar picture, but it considers quarterly growth compared to the previous year (instead of the growth rate for each calendar year; quarterly data has been kept since 1947). This better captures changes in economic activity during a year. For example, the 1973-75 recession was spread over several years. Real GDP was down 0.5% in 1974 compared to 1973 and down another 0.2% in 1975 compared to 1974, apparently mild declines spread over 2 years. However, the decline from the first quarter of 1975 compared to the first quarter of 1974 was 2.3%, which was the second steepest (at that time) decline since WW2. When was the largest decline in GDP over a 12-month period (since 1947)? Economic growth was -4.1% in Spring 2009 compared to Spring 2008. On a positive note, the largest increase was 13.4% in the Fall of 1950. Thus, quarterly data reveals more detail than yearly data.
Some economists have tried to use letters to describe the early stages of economic recoveries. You may notice at least 3 letters in the chart above. Following the deep recessions of 1948, 1953, 1958, 1973-75 and 1982, the economy experienced V-shaped recoveries (sharp rebounds following significant recessions). Meanwhile, the recoveries following the mild recessions of 1990-91 and 2001 had weaker rebounds described as U-shaped (particularly evident with the recovery following 2001). The back-to-back recessions of 1980-82 have been referred to as a double-dip or a W.
Quarterly Growth Rate (note: annualized rate, to be discussed in the next section)
When considering the short-term behavior of the economy, quarterly growth rates (compared to the previous quarter instead of being compared to the same quarter of the previous year) provide more information about turning points in the economy. For example, the US economy started to grow in the third quarter of 2009 even though GDP was lower than it had been 12 months earlier. So the quarterly growth rate was positive, but the rate compared to the previous year was still negative. One quarter's results could be misleading, so economists normally consider trends. For example, in the first quarter of 2014, the economy shrank by 2.1%, but then rebounded to 4.6% growth in the second quarter.
Stop and Think: Economic growth can be estimated for a 12-month period or quarterly - what are the benefits of each? Which figure would you consider if you're interested in the recent trend in economic growth? Which would you consider if you are trying to identify a turning point in the economy?
How does GDP affect businesses?
Obviously, the state of the overall economy affects the performance of individual businesses. A weak economy makes it difficult for most businesses to operate. If the economy is declining, spending will be sluggish or worse, hurting sales at most businesses. However, different parts of the economy behave in different ways. For example, for most of 2008, residential investment was quite weak while exports were very strong. Some forms of spending are more sensitive to the economy while others are less. When it comes to consumption, durable goods tend to be the most volatile, experiencing more significant booms and busts. Why? They tend to be more expensive and also last longer, so, during bad economic times, consumers will continue to use their existing cars, etc, instead of buying new ones. Investment also tends to be more erratic than the overall economy for similar reasons. Thus, companies in different lines of business will be impacted in different ways during a recession.
see link from Briefing.com for the interpretation of the most recent data for GDP and its components
Next: measuring GDP