GDP: Measuring the Economy

If you’ve been listening to the news over the past few years, you’ve probably heard a lot about gross domestic product (GDP) in relation to the Great Recession and the economic recovery. When GDP falls for an extended period, it may signal the beginning of tough economic times. Conversely, a rising GDP may indicate an improving economy and the potential for better times.

Gross domestic product is the total value of goods and services produced in the United States. This includes consumer spending, government spending, business capital investment, and net exports (the value of exported goods minus the value of imported goods). You might look at GDP as a speedometer that measures how fast the nation’s economic engine is running.

What GDP Tells Us

The total dollar value of GDP provides perspective on the size of a nation’s economy. The United States has the highest GDP in the world — about two and a half times greater than China’s, the second-largest national economy.¹

What matters more for investors, however, is GDP growth. When gross domestic product grows, it may help contribute to higher corporate earnings. Interestingly, research has failed to prove that stock market performance has a positive correlation with GDP growth.²

Gross domestic product may also affect interest rates. When GDP growth is slow, the Federal Reserve may keep interest rates low in an effort to stimulate the economy, as it has done since 2008. On the other hand, if GDP rises too quickly, the Fed typically becomes concerned with potential inflation and may raise interest rates in an effort to keep the economy from growing too fast.

Keeping an eye on GDP may be helpful in gauging the overall health of the economy. Yet it could be unwise to place too much emphasis on GDP when making investment decisions.

1) International Monetary Fund, 2011
2) Financial Times, January 12, 2010

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