Understanding Economic Indicators and Fluctuations
Consumer Price Index (CPI) and GDP Deflator
The Consumer Price Index (CPI) measures the average change in prices paid by urban consumers for a basket of consumer goods and services. However, it’s an imperfect measure of the cost of living because it doesn’t account for consumer substitutions to cheaper goods, increased purchasing power from new goods, or unmeasured quality changes. Consequently, the CPI tends to overstate true inflation.
The GDP deflator is another measure of the general price level. Unlike the CPI, which focuses on consumer goods, the GDP deflator includes all goods and services produced domestically. It also differs from the CPI in its treatment of imported goods (which affect the CPI but not the GDP deflator) and its use of a changing basket of goods reflecting the evolving composition of GDP.
Nominal and Real Interest Rates
The nominal interest rate is the advertised rate unadjusted for inflation. The real interest rate, on the other hand, is adjusted to reflect the impact of inflation on purchasing power.
Unemployment and the Labor Market
National statistics offices measure unemployment through surveys like the Labour Force Survey. This survey categorizes adults (16+) as:
- Employed: Includes those working for pay, in their own business, or as unpaid family workers. It also includes those with jobs who are temporarily absent (e.g., vacation, illness).
- Unemployed: Includes those who are jobless, available for work, and actively seeking employment (within the past four weeks). It also includes those laid off and waiting to be recalled.
- Inactive: Includes those not in the labor force, such as full-time students and retirees.
Key labor market indicators derived from this survey include:
- Labor force: The sum of employed and unemployed individuals.
- Unemployment rate: The percentage of the labor force that is unemployed.
- Labor force participation rate: The percentage of the adult population that is in the labor force.
These data help economists and policymakers track changes in the economy. The natural rate of unemployment represents the normal rate around which the actual unemployment rate fluctuates. Cyclical unemployment is the deviation of unemployment from its natural rate.
Economic Fluctuations
Economic fluctuations, often called business cycles, involve periods of expansion (rising income and employment) and recession (falling income and rising unemployment). Recessions are considered mild downturns, while depressions are more severe.
Key Facts about Economic Fluctuations
- Irregular and unpredictable: Economic fluctuations are difficult to predict with accuracy.
- Most macroeconomic quantities fluctuate together: Real GDP, personal income, corporate profits, consumer spending, and investment spending tend to move in the same direction.
- Unemployment rises when output falls: Changes in production are strongly correlated with changes in employment.
Aggregate Demand and Aggregate Supply
Economists use the aggregate demand-aggregate supply model to explain short-term economic fluctuations. The aggregate demand curve shows the total quantity of goods and services demanded at each price level. The aggregate supply curve shows the total quantity of goods and services supplied at each price level.
The aggregate demand curve slopes downward due to:
- Wealth effect: Lower prices increase the real value of household wealth, boosting consumer spending.
- Interest rate effect: Lower prices reduce the demand for money, leading to lower interest rates, which stimulates investment.
- Exchange rate effect: Lower prices and interest rates can depreciate the currency, increasing net exports.
Stagflation, a period of falling output and rising prices, can result from a negative shift in aggregate supply.