The American Economy—An Overview - Measuring The Economy

The Money Supply

The central bank of the United States—called the Federal Reserve and commonly known as the Fed—uses its power to control interest rates in order to manipulate the money supply—the total amount of coins and paper currency in circulation, along with all holdings at banks, credit unions, and other financial institutions.

The total amount of money in the United States at any one time is counted according to three measures (called money aggregates):

• M1: The total amount of paper money and coins in circulation plus all money in checking accounts.
• M2: All paper money and coins, all money in checking accounts, certain savings accounts, money market accounts, and certificates of deposit worth less than $100,000.
• M3: All paper money and coins, all money in checking accounts, certain savings accounts, money market accounts, certificates of deposit over $100,000, euros (the currency of the European Union) held in American accounts, and all repurchase agreements (when securities are sold with the promise that they will be bought back at a later date).

According to the Federal Reserve Statistical Release of February 17, 2005, the M1 count in January 2005 was $1,353 billion; the M2 count was $6,430 billion; and the M3 count was $9,468 billion.

Inflation

Inflation is an increase in prices of goods and services across an economy. It is also sometimes defined as a decline in the buying power of money—in other words, when prices outpace the value of money. In general, when the money supply increases, interest rates decrease, which leads to more spending and causes the economy to expand. Too much expansion causes money to become devalued, so at that point the Federal Reserve typically raises interest rates to cause the economy to contract and lower the risk of a spike in inflation. Government agencies use a number of indexes to measure the way inflation affects individuals and businesses. An excessively high rate of inflation can destroy an economy and lead to dangerous social instability; for example, historians believe that inflation was a principal cause of the economic failure in Germany that led to the rise of Adolf Hitler and, eventually, World War II. According to statistics published by the Bureau of Labor Statistics in March 2005, inflation in the United States has averaged about 4% per year since World War II. For the five years between 2000 and 2004 the annual inflation rate averaged 2.56%.

THE CONSUMER PRICE INDEX. The Consumer Price Index (CPI; also called the retail price index) measures the way inflation affects consumers on a daily basis, tracking price changes for goods and services, including housing, utilities, fuel, food and beverages, travel, and tuition. There are two categories of consumers tracked by the CPI. CPI-U measures All Urban Consumers and is the most commonly cited component of the CPI. CPI-W measures Urban Wage Earners and Clerical Workers; it is used in negotiating salary increases in contracts. The Chained Consumer Price Index (C-CPI-U) is a newer index that many consider to be a more accurate measure of the cost of living. CPI-U and C-CPI-U reflect about 87% of the total U.S. population and include not just general wage earners but professionals, managers, technicians, and the self-employed, along with retirees, the unemployed, and others not in the labor force. Table 1.1 shows the CPI for 2002 and 2003.

The Bureau of Labor Statistics uses CPI data to track the prices of products and consumer buying power over time. For example, the BLS estimates that the purchasing power of $100 in 1945 was equal to $298.89 in 1975 and $1,065.56 in 2005. A loaf of white bread that cost about seventy-seven cents in February 1995 cost $1.00 in February 2005, and Grade A large eggs that were eighty-six cents per dozen in February 1995 cost about $1.05 in February 2005. In addition to grocery products, CPI data also tracks electricity and fuel. According to the BLS, a gallon of regular unleaded gasoline that cost $1.13 in February 1985 was actually less expensive in February 1995 ($1.12) but then rose 77.7% to $1.99 by February 2005.

PRODUCER PRICE INDEXES. Producer Price Indexes (PPIs; formerly called Wholesale Price Indexes) measure changes over time in the prices received by U.S. producers of goods and services; in other words, PPIs track prices from the viewpoint of sellers rather than buyers. The amount of money paid for goods and services is often different from the amount of money producers actually receive because of taxes, distribution costs, and government subsidies. Regular PPIs are available for the mining, manufacturing, trade, finance, and service sectors of the economy—as well as for individual products and groups of products—and are organized according to product endusers and materials used in production. According to the Department of Labor, between 1985 and 2003 the PPI for finished consumer goods increased an average 2.05% annually. During the five years from 1999 through 2003 the PPI for finished consumer goods increased an annual average

TABLE 1.1

of 2.44%, which was slightly higher than the annual average inflation rate of 2.32% during the same period. Table 1.2 shows the PPI for intermediate goods and crude goods from December 2003 through November 2004.

IMPORT AND EXPORT PRICE INDEXES. The Import Price Indexes (MPI) and Export Price Indexes (XPI) are kept by the International Price Program to measure

changes in the prices of nonmilitary goods and services that the United States trades with other nations. These products and services include a wide range of imports to the United States and exports from it to other countries, such as petroleum, livestock, automobiles and vehicle parts, clothing, crops, chemicals, precious stones, and international airline service. The Import and Export Price Indexes released on March 18, 2005, by the Bureau of Labor Statistics indicated that overall import prices rose 0.8% in February 2005, while the overall Export Price Index was unchanged after a rise of 0.9% in January 2005. Import prices in February 2005, however, were 6.1% higher than they had been in February 2004, largely because of a 29.6% increase in petroleum products during that period. However, over the five years between February 2000 and February 2005 import prices had risen during some periods and fallen during others, ending with a 6.4% increase overall. Petroleum imports had increased

by approximately 71% over the same five-year period. The price of U.S. exports to other countries during the five years from February 2000 through February 2005 had risen 6.1%. These increases were higher than the inflation rate, which was averaging roughly 2.5% annually during the early 2000s.

THE CONSUMER EXPENDITURE SURVEY. The Consumer Expenditure Survey (CE) is actually two kinds of surveys—one an interview and the other a diary—that the BLS uses to gain information on consumer spending habits and demographic characteristics. The CE is used by the BLS to revise the Consumer Price Index. Public and private agencies also use the data collected to study the economic wellbeing of various segments of the American population.

Gross Domestic Product

The Gross Domestic Product (GDP) measures in dollars the total value of U.S. goods and service output in a given year. It is one of the most important and accurate ways the government tracks the health of the economy. In the United States the GDP more than tripled in a twenty-year period, from $3.4 trillion in 1983 to approximately $11 trillion in 2003. In Table 1.3 the left-hand column shows the actual number of dollars for a given year, while the right-hand column shows the number of

TABLE 1.2

GDP dollars adjusted for inflation to the year 2000. In 2003, according to estimates by the Central Intelligence Agency (CIA), the GDP of the United States was $10.4 trillion, almost twice as large as that of the next closest country, China, at $5.7 trillion. The world's total GDP in 2003, according to the CIA, was $49 trillion. Table 1.4 shows CIA estimates of GDP figures for the top twenty-five countries in 2003.

Every three months the U.S. Commerce Department releases quarterly GDP figures, and economists use a variety of indicators to determine what may have caused rises and declines in the numbers. Among other factors, they look at consumer spending (see Table 1.5), durable goods purchases (see Table 1.6), nondurable goods purchases, and savings levels, which become particularly important during economic downturns, when Americans earn less and need to tap into their savings to make purchases, which keep the economy moving forward.