Gross Domestic Product, known by its acronym GDP, is a primary metric used to measure the health of an economy. The United States Bureau of Economic Analysis (BEA) – a division of the Department of Commerce – releases GDP information on the US economy every quarter.
The four quarters of the year are:
Quarter 1: January – March
Quarter 2: April – June
Quarter 3: July – September
Quarter 4: October – December
A month after each quarter ends, the BEA releases its Advance GDP estimate. This estimate of the previous quarter’s GDP is based on incomplete information, though it provides the first indication of the last quarter’s GDP. In the second and third months following the quarter’s end, “second” and “third” GDP estimates are released as more information is received and revisions are made to the GDP estimate.
What is GDP
Gross domestic product is the “total monetary or market value of all the finished goods and services produced within a country’s borders in a specific time period.”
Two types of GDP are often referenced: Real GDP and Nominal GDP.
Nominal GDP is the GDP measured using current market prices. Real GDP is when the GDP is calculated using fixed prices.
For example, the nominal GDP of a country could be five trillion dollars in 2015. In 2016, it could be six trillion dollars and in 2017 it could be seven trillion dollars. According to this measurement, the GDP is increasing by a net one trillion dollars per year. This GDP is calculated based on the prices of goods and inflation within each year. However, the problem with this calculation is that it doesn’t measure growth accurately. The reason for that is because each year’s GDP is calculated based on the value of the currency and prices of that specific year.
This is the problem that Real GDP comes to address.
Real GDP would take the three years mentioned above and calculate the GDP based on prices and the currency value in 2015 or another baseline year. Therefore, if the GDP rose one trillion nominally between 2015 and 2016, the Real GDP calculation would estimate how much did the GDP grow based on the prices and currency value in 2015. In this case, the calculation might find that the GDP grew only 600 billion dollars when factoring in prices and inflation throughout 2016.
Calculating GDP
One of the most common ways of calculating GDP is based on money spent by different groups in the economy.
The GDP formula is:
C + G + I + NX = GDP
C = consumption
G = government spending
I = Investment
NX = Net Exports
This formula groups together “consumption” which refers to all the private consumer spending within a country’s economy; “government spending” which is the government’s budget; “investments”, which reflects private domestic investment projects such as business investments in their various activities to maintain and expand the business; and “net exports” which is calculated as exports minus imports.
Advance GDP’s impact on the financial market
The Advance GDP numbers can affect different sectors of society in different ways.
Investors can view the GDP estimates as it relates to companies and their earnings. Strong economic numbers mean companies are prospering which impacts stock prices. Weak economic numbers may signal that the market is going down.
Built into stock prices is a certain assumption of GDP growth. Therefore, when the GDP is more or less what has been expected, stock prices may not be impacted. However, when GDP numbers exceed or fall below expectations, therein lies the potential for shocks to the market. Despite this, the Advance US GDP is incomplete and as information flows in throughout the upcoming months, the final GDP can be significantly different from the first numbers publicized in the Advance US GDP.
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Advance GDP’s impact on the US government
The strength of the economy can also help or hinder a government from advancing their agenda. For example, a strong economy could be used by a government to legitimize additional government programs or increased spending on an array of issues. A weak economy could generate pushback from the public if it sees that the government is engaged in perceived wasteful spending. Weak GDP numbers can also put pressure on a government to act to improve the economy.
For politicians, especially presidential candidates, the advanced GDP numbers can impact the outcome of the election. Elections for the US President are held every four years in early November. Advanced GDP numbers for the third quarter of the year are usually published a week prior to the elections at the end of October.
For the incumbent candidate, positive advanced GDP numbers can provide a tailwind to their campaign, whereas poor economic numbers can provide a boost to the opposing candidate looking to unseat the President.
Congressional elections are held every two years at the beginning of November. Incumbent members of Congress looking to shore up their bona fides can point to good economic numbers as proof that they are doing their job well.