Every month or sometimes every quarter, governments around the world release economic statistics. Markets will often wait for the release of these statistics and billions of dollars of investments will often hang on what these statistics reveal. While the announcement of economic data will often make the news, many people aren't aware of what these statistics actually mean. Oftentimes, they reflect something totally different than what their name might imply.
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Listen now to the Up First podcast from NPR. If you pay attention to the news, it's only a matter of time before you come across some economic statistics. data on unemployment inflation and economic growth is published on a regular basis by countries around the world This data is used to make extremely important economic decisions in both the public and private sectors
It's not an exaggeration to say that trillions of dollars globally are spent and invested on the basis of this data. This data, however, does not come out of nowhere. It has to be calculated and there needs to be a definition of exactly what it is that's being measured, which is actually a lot more tricky than you might realize.
Each country has one or more agencies that are tasked with gathering and producing economic data. While there might be some differences in how the data is gathered and calculated, for the most part, it's largely similar. There are many, many different economic statistics that exist, and there are many different ways to view economic activity.
For the purpose of this episode, I'm going to focus on how economic data is collected for the United States, just because it's the world's largest economy and it isn't radically different from other countries. So let's start with this statistic that is probably the most important and widely used gross domestic product or GDP. GDP is intended to show the overall amount of economic activity in a country.
There are two ways that economists can calculate GDP, both of which should, in theory, arrive at the exact same number. The first looks at total expenditures. In this method, GDP equals total consumer spending, plus total business investment, plus total government spending, plus the difference between exports minus imports. The second method involves income. This way, GDP equals wages plus rents,
plus interests, plus profits, plus taxes. Growing up, the statistic that was always used was GNP, or Gross National Product, and the two numbers are very similar. GDP measures the total value of goods and services produced within a country's borders, while GNP includes the value of goods and services produced by a country's residents.
regardless of whether the production occurs domestically or abroad. For example, if you are an Australian working in the U.S., your income would be part of Australia's GNP and the United States' GDP. The difference between GNP and GDP is pretty minor, usually within a single percentage point.
In 1993, the system of national accounts, which is the international organization that creates the standards for national economic accounting, switched from GNP to GDP as GDP was a better reflection of economic activity within a country. country's borders. GDP, especially historical or comparison figures, can be reported two ways. There's nominal GDP and real GDP.
Nominal GDP measures the total value of goods and services using current prices, while real GDP adjusts for inflation to reflect the true value of economic output over time. More on inflation in a bit. GDP does not measure informal or black market activity. That means it can't capture the economic activity of the illegal drug trade, for example. But it also doesn't capture much economic activity which is conducted in barter or cash.
This is a much bigger problem in developing countries where enormous sectors of the economy are conducted informally. Estimates put the unrecorded informal economy in some developing countries as high as 25 to 40% of GDP. By the same token, some things are counted as GDP which do very little to raise standards of living.
Disaster recovery spending, needless construction projects, or large infrastructure projects paid for with foreign debt can show up as GDP. The next economic statistic that gets a lot of attention is the unemployment rate. The unemployment rate seems pretty straightforward. It measures the number of people who don't have a job. However, it isn't quite so simple. Children don't have jobs, but it would be silly to count them as unemployed.
The same goes for people who are retired, college students, or those who are disabled and can't work. Likewise, there are some people like homemakers who are not actively part of the counted labor force. And there are some people who just have rich parents and play video games all day. So the unemployment rate is calculated as the number of unemployed people divided by the total labor force, multiplied by 100 to make it a percent.
unemployed is defined to be people who are actively looking for work but cannot find a job the total labor force is just the number of unemployed people by this definition plus the number of employed One of the biggest problems with the unemployment rate is what is known as discouraged workers. People have been looking for a job for a long time without any success and eventually just give up.
This can become especially pronounced when times are very bad, which means that the higher the unemployment rate is, the greater the odds that it's actually underreporting, because it doesn't count discouraged workers. There are also always going to be people who are between jobs or people who lose jobs for cause or something that was out of their control. For that reason, full employment is not considered to be 0% unemployment.
Most economists would put full employment at around 4-5%. Inflation is a difficult measurement and is probably one of the most difficult to measure. The traditional measure given for inflation is the Consumer Price Index or CPI. Everybody knows that prices go up over time and sometimes prices rise faster than others.
However, measuring the overall increase in prices across the entire economy is very difficult to do. The CPI is the change in the price of a basket of goods that is tracked as a proxy for the overall economy. There are a host of problems with the CPI as a measurement. For starters, there's no way to know just how representative the basket of goods is. Second, they're changing what is measured in the
All the time. Over the last 20 years or so, there have been about 30 changes to the CPI. And since 1919, when it was first calculated, there have been no fewer than six major changes to how the CPI is calculated and weighed. That means if you go back in time to make price comparisons, you're going to be using a metric that is fundamentally measuring different things. Another problem is that some things like technology get better over time.
Personal computers and mobile phones are much more powerful than they were 20 years ago. Even if the price for a device were to go up, and in the case of technology, usually goes down, How do you compare a modern computer with something that's decades old? There's also a problem with substitution. If beef gets expensive, for example, people might switch to pork or chicken.
which would then throw off the importance of beef in the index. If you replace beef with chicken in the index, then it would reflect lower prices, when, in fact, prices have gone up, which is why the substitution took place in the first place. One of the most important expenses for most people is their rent or mortgage. However, the CPI doesn't actually measure that directly. Instead, it measures...
owner's equivalent rent, which estimates what a homeowner could get if they rented out their house rather than what they actually pay. And then of course, there's the problem that different places have different prices. A hamburger at McDonald's in New York City will cost much more than the exact same thing in Des Moines, Iowa. Because the CPI is so opaque compared to other economic statistics, it's more prone to manipulation.
Many countries will adjust what is in the package of goods to make inflation appear lower so they can then spend less on pensions and welfare payments that are adjusted for inflation. Many people look to the money supply as an alternative to CPI The primary measure of the money supply is known as M2. M1 is a measure of all of the money that is in cash or checking accounts, basically any money that is very liquid and could be spent immediately.
M2 is just M1 plus money in savings accounts and other short-term investments like CDs. The reason why M2 is considered a measure of inflation is because inflation is usually considered to be a reflection of growth in the money supply. The final statistic I want to discuss isn't actually a government-issued statistic, but it's often used by people as a proxy for the overall economy. The stock market. Various stock market indices are used as a proxy for the overall economy.
the most popular of which is the Dow Jones Industrial Average. I previously did an episode on the subject, but to summarize, the Dow Jones is nothing more than a collection of 30 popular and successful stocks. And that really is the thing to know about the Dow Jones, that it is not an overall measure of economic activity or even all stocks. It's just 30 stocks. The stocks that are represented change every few years.
Over a long enough time, the stocks in the Dow Jones are completely different. The Dow Jones Industrial Average is not the only measure of the stock market. There are several others that include more stocks, including the Standard & Poor's 500, the NASDAQ Composite, the NASDAQ 100, the Russell 500, and the Wilshire 5000. Oddly enough,
The broader the index with more stocks, the more accurately it represents the state of the economy. However, the smaller indices like the Dow Jones are almost always the more popular ones. There are several things you need to keep in mind. The first of which is, of course, that the Dow Jones is only 30 stocks. Second is that the stocks listed in the Dow Jones are selected because they are good, profitable companies.
And that means, by definition, you should expect the index to probably outperform the general economy because it's only looking at a successful subset of the economy. However, there's more to it than that. Neither the Dow Jones or any of the other stock indexes are adjusted for inflation. That means when you look at the increase in the index, you need to manually adjust it for inflation to get a true sense of how much it really increased.
There is another thing that most people don't realize, and it has to do with index funds. Index funds have become a very popular way of investing. Basically, you invest in a fund that mirrors the composition of the index. I'm not saying it's a bad way to invest, as index funds have done quite well. However, once a stock is added to an index, all the index funds are obligated to buy it simply because it's now in the index.
And that means that any stock that's listed on an index will have, at least at some level, some artificial demand for the stock compared to other stocks that are not in the index. The point of all this is that any stock index is going to have factors that do not necessarily reflect the underlying economy. And there's one other thing about economic statistics that you have to consider. In some cases, the government that produces them
Could just be outright lying. When the Soviet Union was around they were notorious for just fabricating their economic data. They announced growth rates that were more about propaganda than they were about any sort of fundamental economic reality. A country doesn't even have to make outrageous claims in their data to cause huge problems. Even exaggerating growth by 1% every year will have compounding effects over just a few years that will make the economy out to be something that it isn't.
Economic statistics are very important. They're necessary for both policymakers and investors to make important decisions. However, calculating them can be extremely difficult. So when you encounter them in the news, It's just important to know what they are, what they're actually measuring, and what their potential flaws are.
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