Economic Indicator Project - analysis of the US Economy and Advice to the Fed.

by tarheels23 (student)

University Degree Business and Administrative studies

Economic Indicator Project

Brian Tessler

AP Economics

Mrs. Fischer

17 December 2012

The current condition of the economy can be described as stagnant recovery. Although the economy has been recovering, it is doing so at a slower pace than people had hoped and expected. These trends can be seen in many of the major economic indicators, including Consumer price index, Gross Domestic Product, industrial production, and retail sales. As a result, the U.S. economy has still not fully rebounded from the recession.

Consumer price index is extremely important to the total economy because it is a measure of the change in the average price level of a fixed basket of goods and services purchased by consumers. CPI is the most widely followed monthly indicator of inflation. The CPI is considered a cost-of-living measure since it is used to adjust contracts of all types that are tied to inflation. Labor contracts are tied to changes in the CPI; Social Security payments are tied to the CPI; and even tax brackets are tied to the consumer price index. As for the current condition, consumer price inflation dropped in November on lower energy costs and the core rate softened. The consumer price index in November fell 0.3 percent, following a 0.1 percent increase the month before. The latest number posted lower than the consensus forecast for down 0.2 percent. Over the last year, CPI has been extremely volatile. It was on a sharp increase in the first 6 months, but since then it has been sloping downward. This volatility is extremely negative for an economy that needs price stability during this time of recovery and does not bode well for future price expectations. If these dramatics changes continue, consumers may lose confidence in the value of the dollar which could have detrimental effects on the economy. When evaluating the CPI, the FOMC needs to continue monitoring the inflation rate and take the necessary open market operations. They must continue buying securities in order to stabilize inflation at the goal of around 2%.

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GDP may be the single most important indicator to the total economy because is the broadest measure of aggregate economic activity and encompasses every sector of the economy. The current condition was of GDP growth for the third quarter, but the composition deteriorated. The Commerce Department put the second estimate at 2.7 percent annualized, compared to the advance estimate of 2.0 percent and second quarter rate of 1.3 percent. But the composition shifted toward inventory investment and away from demand components. Final sales of domestic product rose 1.9 percent versus the advance figure of 2.1 percent and second quarter growth of 1.7 percent. It increased this last quarter, but GDP can be volatile so it is beneficial to look at trends over a longer period of time. Over the last 2 years, real GDP has leveled out at a small increase around a 4.0% change annualized. This demonstrates the overall condition of the economy which is of a slow recovery pace. The future of GDP is concerning, because although it increased, the composition changed for the worst. It shifted toward inventory investment and away from demand components, which can hurt the economy if it continues in the future. The inventory investment leads to an increase in goods that are held on to for longer periods of times. Since they are not being sold, it is not helping the product market and is a deceiving increase in GDP. If the Federal Reserve Bank only looked at GDP, it would implement a large-scale expansionary policy in which the FOMC would buy securities and the Fed would lower discount rates and the reserve ratio. As a result, the increase in money supply and loans would lead to more consumption and investment to boost GDP.

The index of industrial production is important to the total economy because it shows how much factories, mines and utilities are producing. Industrial production indicates not only trends in the manufacturing sector, but also whether resource utilization is strained enough to forebode inflation. Lastly, industrial production is an important measure of current output for the economy and helps to define turning points in the business cycle, such as a start of recession or a start of recovery. As for its current condition, industrial production rebounded in November with notable help from recovering from Hurricane Sandy and a boost in auto assemblies. Overall, industrial production rebounded 1.1 percent, following a decline of 0.7 percent in October. Although this is a positive, it is only a slight increase and does not change the fact that industrial production has been pretty much stagnant over the last 2 years. Since early 2011, industrial production has remained in a positive change percentage, but it is has been slowly declining. Just like the economy as a whole, it is recovering but at a very slow pace. Unfortunately, the future of industrial production does not hold much up for any change. It appears that it will continue to change at a very slow rate for the apparent future. This provides the risk to the U.S. economy that it will remain in a state of stagnation and curb efforts to recovery. Hypothetically, if industrial production was the only thing the Federal Reserve Bank evaluated, it should lower the reserve ratio. This would increase the amount of loanable funds banks have and would lead to more borrowing. This is in turn would hopefully lead to an increase in investment, which would benefit industrial production.

Retail sales are indicative of the economy as a whole because it measure the total receipts at stores that sell merchandise and related services to final consumers. Essentially, retail sales cover the durables and nondurables portions of consumer spending. Consumer spending typically accounts for about two-thirds of GDP and is therefore a key element in economic growth. As for its current condition, retail sales made a moderate comeback in November despite a drop in gasoline prices. Autos were up as well as the key core component. Total retail sales in November rebounded 0.3 percent, following a 0.3 percent decline the prior month. Other than a spike in the summer of 2012, retail sales has experienced a slight decline for the last 2 years. Although it has remained in positive change, each month, it has pretty been trending downward. Once again, this is indicative of the economy which continues to recover at a slow rate. The future is more positive for retails sales due to the increase in this last month of November. This has economists optimistic for a larger rebound in retail sales and they are projecting an increase for the coming month. However, there is a risk if retail sales don’t increase like projected because business may overproduce, which would lead to a surplus of goods. This could potential flood the market with excess goods, which would drop prices and hinder price stability. If the Federal Reserve Bank was only concerned with retail sales, then the FOMC would buy more securities in order to increase the money supply. This would increase in aggregate demand, and thus also raise the demand for retail sales.

Based on the current state of the economy and the results found in these indicators, the Federal Reserve’s greatest priorities must be maximizing employment and price stability. In order to ensure that inflation is at consistent level around the goal of 2%, the FOMC must continue to purchase mortgage-backed securities. Additionally, the FOMC should also purchase longer-term Treasury securities after its program to extend the average maturity of its securities is completed at the end of the year. The Fed should also roll over maturing Treasury securities at auction in order to maintain downward pressure on longer-term interest rates and support mortgage markets. Finally, the Fed should keep the federal funds rate at its current range between 0% and .25% as long as there is still high unemployment. This low rate will keep stabilized interest rates, which is needed in the current money market in order to foster economic growth.

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Works Cited

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United States. Board of Governors of the Federal Reserve System. Beige Book, November 28. Federal Reserve. Web. 16 Dec. 2012. <http://www.federalreserve.gov/monetarypolicy/beigebook/beigebook201211.htm>.

United States. Board of Governors of the Federal Reserve System. Beige Book, October 10. Federal Reserve. Web. 16 Dec. 2012. <http://www.federalreserve.gov/monetarypolicy/beigebook/beigebook201211.htm>.

United States. Board of Governors of the Federal Reserve System. Minutes of the Federal Reserve Bank. Federal Reserve. Web. 16 Dec. 2012. <http://www.federalreserve.gov/newsevents/press/monetary/20121212a.htm>.

United States. Federal Reserve Board of Governors. Economic Calendar. Nasdaq. Web. 16 Dec. 2012. <http://www.nasdaq.com/markets/us-economic-calendar.aspx>.