What is GDP?
GDP, gross domestic product, is the total value of goods, services, government spending, and investments made in a country. For example, a Ford F-150 made in America is counted towards our GDP, but a car made in another country but sold in the United States, like a Subaru Crosstrek, would count towards Japan’s GDP.
GDP is made up of 4 key parts: Consumption, Business Investment, Government Spending, and Net Exports. Consumption makes up a large part of GDP, as this category includes all goods and services made and sold in the United States. Business Investment is the new factories, tools, equipment, etc that businesses need to grow and sell more products. Government Spending includes all spending by the government that isn’t given directly to people, like stimulus checks. Infrastructure spending would be a category of government spending that affects GDP. Net Exports is defined as Value of Exports - Value of Imports. For the US, the Net Exports category of GDP has been negative for some time, as we import more goods from other countries.
Why Does It Matter?
GDP measures the economic growth for a country. While GDP is not a good measure of quality of life in a country, it does give insight into a country’s wealth and power. The United States accounts for 15.74% of global GDP, while only making up 4.25% of the world’s population. This is because the American consumer is generally much stronger than most consumers worldwide, allowing the US to have a higher GDP than countries with larger populations.
GDP is important to measure the health and well-being of an economy. When GDP is growing, a country’s economy is growing, which is healthy for business. When GDP stops growing and begins to decline, fears over a recession begin. Two quarters of negative GDP growth marks the beginning of a recession. Recessions are a naturally part of the business cycle, in which we see periods of GDP growth, followed by declines in GDP. Recessions can bring job loss and financial distress, but are often unavoidable.
Recessions
While many people believe we should never have a recession, this is economically not possible. Recessions exist to get rid of inefficiencies and over-speculation in markets. An example of this would be the Great Recession following the housing market collapse in 2008.
This chart shows the absolute devastation in the housing market during the housing bubble. While there are fears this could be repeated, it is unlikely, as leading up to 2008, it was too easy to get loans that buyers would never be able to pay back, risky investments by firms into mortgage-backed securities, and the Federal Reserve raising interest rates, killing demand, causing liquidations of properties.
But this recession allowed for better regulation and protection for home buyers, hopefully preventing a collapse at a 2008 level again. This recession, the Great Recession, saw unemployment peak at 10%, and was one of the longest on record. That being said, not all recessions are this severe. Recessions recently have occurred roughly every 10 years, and historically every 4 years. This is because recessions are a part of the natural business cycle, which sees periods of growth and periods of decline. Delaying either part of the business cycle can cause the next cycle to fall into the extremes, which can damage long term growth.
Why is this Important Now?
With lots of talk about a potential recession, it is important to understand where we stand. As of today, the final revision for Q1 2022 GDP came in at -1.6%, meaning the United States economy shrank 1.6% as compared to Q1 2021. 1 more negative quarter of GDP and we are in an official recession. Q2 2022 ends this week, we will know if we are in a recession or not in the next month. While many economists are saying we will not have a recession this year, it is important to note that many economists are wrong, a lot. In fact, economists are trusted less than meteorologists.
At the end of the day, a recession is out of our control. With the Federal Reserve raising interest rates to combat inflation and coming off of a period of high growth due to stimulus after the COVID pandemic, a recession is inevitable. Saving as much money as possible and being prepared is the best possible way to be prepared for a recession, and always remember that just as there will always be another recession, there will always be another period of great economic growth.