Open up the above link for Consumer Spending (or just look at the chart above that was reproduced from the link). You should see a chart (the second one down on the page) entitled “Real Consumption” that tells you a lot about the ups and downs of consumer spending for the last 25 years in the U.S. The sub-title tells you that this is “percent change from a year ago, quarterly data.” This means that there is a point on the chart for every quarter. Each quarter’s value on the chart is the percentage change to that quarter (say the second quarter of 2002) from that same quarter a year before. Notice too that the St. Louis Federal Reserve Bank puts grey bars on all these charts so you can see when recessions occurred. Recessions are time periods when economic activity is generally declining (we will have a more precise definition of a recession later.)
There are two lines in this chart – one for real total consumer spending (use the right-hand-side scale to measure) and the other one for real durables (mostly vehicles and appliances, use the left-hand-scale to measure). Notice the quarters in the mid-1990s– these are the highest points on the chart. We see that 1999 was quite a year for growth in consumer spending. Total consumer spending grew by almost 5% while durable goods grew by almost 16%. Looking at the whole time period you might guess that the average annual growth of total consumer appending was about 3% while consumer durables averaged about twice that much%. What else can we see with our eyeballs?
The values on this chart refer to real consumer spending. See more below about what real means. But for now, just know that the word “real” implies something about quantity or volume.
|If the chart says the annual percentage change in real consumer spending over four quarters was 8%, then that means that the quantity of goods increased by that amount. If prices of these goods rose, then the actual spending measured in current prices would have increased by more than 8%.|
From the chart it looks like the average growth of consumer spending was increasing during most of the 1990s – but then that trend gets crazy after the recession in 2001.
We can also see that the lines were almost always above the zero axis – a positive percentage change means that spending of consumers was almost always growing from one year to the next in each quarter. The lines did go below the zero axis a few times in past recessions – implying that consumers spent less during at least a few quarters. In the recession of 2001, the growth rate of consumer spending fell but the line stayed above the axis – implying that consumers spent more than in the year before. Thus, the 2001 recession was a little different than past recessions in that regard….consumers weakened but didn’t falter!
AD component application
When experts talk about why AD has been growing too fast or too slow, they usually frame their discussions around such things as:
- Consumer confidence and its impact on purchases of autos – part of C
- Why high interest rates might be reducing housing demand – I-R
- How obsolescence of computers might reinvigorate business investment – I-NR
- Why reducing large government deficits might reduce the spending stimulus from government — G
- Why a declining value of the dollar might be expanding demand from foreigners — NX
- When companies purposely increase inventory levels this may be a sign of their optimism about future increases in demand — ΔINV
Okay – so now we know what GDP is and how you can talk about it or calculate it by taking the AD approach.
But here’s a caution –
There are two different versions of GDP and they are used for different purposes and they are quite different in meaning. So we have to be aware that nominal GDP is quite different from, though very related to real GDP (RGDP). Let’s get into these two concepts now.
Nominal GDP is a concept that is very much like revenue. Revenue is the product of two things – price and quantity. So when revenue of a company increases from $100 to $120, without further study you would not know how much of that $20 increase this year was the result of selling more units of quantity (volume) and how much was the result of higher prices. Revenue is useful to you but it doesn’t tell you everything you might want to know. Well – nominal GDP is the value of GDP each time period – where the value reflects the current quantities of all goods and services and their current prices.
When a nation’s nominal GDP goes up by, say 5%, in a given year, you don’t know by how much quantity of output went up or by how much prices went up. That is why the clever statisticians invented Real GDP.
Real GDP is a measure of the quantity or volume of goods produced in the nation. If we knew that nominal GDP increased by 5% and we also knew that Real GDP grew by 2% — then we would know a lot more.
The GDP implicit price deflator is a measure of the prices of all goods and services produced in the nation. Technically speaking we say we “deflate: nominal GDP to arrive at a number of real GDP because the following equation is true:
Real GDP = Nominal GDP/ the GDP Implicit Price Deflator
For example – we know that nominal GDP in 2004 was about $11.7 trillion. For the same source we can find that real GDP was about $10.8 trillion. So how much was the value of the GDP implicit price deflator in 2004? Answer: 1.083.
Recall that analysts like to use percentage changes – and this case is no different. If the above equation is true, then you can do some really cool math and come up with the following equation that is approximately true (approximately true is another way of saying it is not exactly true – and it gets worse the larger are the numbers!)
%ΔRGDP = %ΔNominal GDP – %Δ Implicit price Deflator
Let use this now. Real GDP went from $10.8 trillion in 2004 to $11.1 trillion in 2005. That was a 2.8% increase. Nominal GDP went from $11.7 trillion to $12.5 trillion in those two years for an increase of 6.8%. So how much did prices change in the US? Answer: prices changes by about 4.0% (= 6.8% – 2.8%).
Let’s see if you can apply this idea flexibly. Let’s suppose I tell you that next year Nominal GDP will increase by 3%. I also believe that prices will increase by 4%. What is your conclusion about the percentage change in Real GDP? Answer – RGDP will decrease by 1%. You just forecast a recession!
In this course we don’t have the time or interest in delving into the arcane practice of calculating real GDP. So we will be very brief. Real GDP is obtained essentially by using past prices instead of current ones to value current outputs.
That is, Real GDP is the total value of all goods and services produced this time period where each quantity of good and service produced is valued by a set of past, fixed prices (instead of the current prices). By using a set of past fixed prices when we calculate Real GDP for each time period the only thing that can cause the change each period is volume or quantity change.
I know I know – it sounds fishy. But believe us, while all experts understand that this practice is not perfect, it is the widely accepted practice and gives us pretty much what we want.
Here is a link to some charts which show recent changes in real and nominal GDP:
Notice the bars for the first three quarters of 2011. The chart for nominal GDP shows growth rates that are close to 4%. In the real GDP chart, the values are around 2% or less. Why are the nominal GDP changes about 2% higher (if we had a table of reported figures we could be more exact) than the corresponding real GDP changes? Answer: Because nominal GDP measures price and quantity change. Real GDP measures only quantity change. So we can infer that the 2% is the amount of price change or inflation. During those three quarters output was growing at about 2% and prices at about 2%.
Here is a chart of Real GDP changes over the last quarter of a century: http://research.stlouisfed.org/publications/net/page4.pdf
RGDP growth was generally positive but with uneven cycles. It is quite rare for US RGDP to grow by 5% or more in a given year. More typical is 2.5 to 3%. It takes a pronounced decline in growth for a year to be called a recession. In 2001 the growth rate was positive but it was very near zero. In 1990, 1991, 2008 and 2009 we have RGDP declining.