Section 5, Economics And Economic Indicators

Recession

A mild consecutive six-month decline in stock prices, business activity, and employment; or two consecutive quarters of negative GDP growth.

Recovery Period

An increase in GDP for at least two consecutive calendar quarters.

Inflationary Period

Too much money chasing too few goods, leading to rising prices and interest rates. The Federal Reserve combats this by tightening money supply (selling government securities and raising the Discount Rate).

Effect of Inflation on Bonds

Interest rates rise, bond prices decline.

Effect of Deflation on Bonds

Interest rates fall, bond prices appreciate.

Investor Strategy in Inflation

Buy short-term bonds if anticipating rising interest rates.

Investor Strategy in Deflation

Buy long-term bonds if anticipating declining interest rates.

Core Inflation

Narrower measure of inflation excluding food and energy prices.

Cost-Push Inflation

Occurs when supplier costs increase, reducing supply and causing higher prices.

Demand-Pull Inflation

Occurs when demand exceeds supply, causing suppliers to raise prices.

Keynesian Economic Theory (Demand-Side)

Advocates active government intervention through spending and taxation to stabilize the economy.

Monetarist Theory

Believes controlling the money supply impacts the economy more than federal spending; favors steady money supply growth.

Supply-Side Economic Theory

Advocates lower taxes and smaller government to stimulate the economy.

Classical Economic Theory

Supports laissez-faire economics, with markets best left alone to find equilibrium.

M1

Currency in circulation plus demand deposits (checking accounts, traveler’s checks).

M2

M1 plus money market fund balances, repurchase agreements, savings accounts, and time deposits under $100,000.

M3

M2 plus time deposits of $100,000 or more.

Leading Economic Indicators

Forecast future economy; include average workweek, new housing starts, new business formation, M2 supply, vendor performance, new durable goods orders, stock prices, equipment orders, consumer expectations index, unemployment claims, unfilled durable goods orders.

Coincident Economic Indicators

Move with the economy; include personal income, industrial production index, retail sales, GDP, and non-farm payrolls.

Lagging Economic Indicators

Follow the economy; include labor costs, existing housing sales, capital spending, commercial/industrial loans, unemployment rate, bank prime interest rates, and corporate profits.

Gross National Product (GNP)

Total value of goods and services produced worldwide by a nation’s citizens. Must be measured in constant dollars.

Gross Domestic Product (GDP)

Total value of goods and services produced within U.S. boundaries. A better measure of U.S. economic health than GNP.

Producer Price Index (PPI)

Monthly measure of wholesale/producer prices for commodities like food, lumber, oil, and gas; indicates future CPI changes.

Consumer Price Index (CPI)

Monthly measure of price changes in consumer goods/services; main measure of inflation; also called Cost of Living Index.

Disintermediation

Large-scale withdrawal of funds from banks/S&Ls into money market instruments or bonds for higher yields.

Disposable Income

Personal income after taxes; can be spent or saved.

Discretionary Income

Income left after essentials (food, housing, utilities) are paid; key economic indicator for consumer spending.

Business Cycle

Expansion (recovery, rising rates), Peak (top of expansion), Contraction (recession, falling rates), Trough (bottom of recession).

Expansionary Period

Demand, production, employment, and profits increase.

Elastic Demand

Consumers respond significantly to price changes (e.g., movies, air travel, restaurants).

Inelastic Demand

Consumers do not respond significantly to price changes (e.g., coffee, utilities, cigarettes).

Unitary Elastic Demand

Change in demand equals the price change (e.g., housing, recreation). #