If you follow current events, read the newspaper, or watch the nightly news (and if you don’t I will give them to you here) you hear all sorts of numbers regarding the economy from unemployment, inflation, GDP, etc. What do they all mean for the economy going forward?

First lets look at some of the numbers:

Inflation: 3.3% through November 2011 (using the CPI)
Unemployment: 8.5% through December 2011
GDP Growth: 1.8% in Quarter 3

INFLATION

I will start with analyzing the inflation rate. This number was calculated using the Consumer Price Index (CPI) and is a reflection of all prices from November 2010 to November 2011. The typical target rate for inflation by the Fed is 2%, however in recent years it has varied, inflation was 4.2% in 2007 and 1.04% in 2010. Now, there is a lot of talk about inflation in the news and amongst the political pundits, especially the concern of high inflation. Now, as I have written before, yes there is a chance that we could see very high inflation in the United States, however it is very unlikely. The Fed underwent several changes to monetary policy in the last few years and they were called Quantitative Easing (QE1, QE2, etc.). A big word, but all Quantitative Easing is the Feds attempts to increase the money supply in order to keep interest rates low to attempt to spur economic growth. There is a large misconception about interest rates and the money supply. The Fed does not directly control interest rates, it heavily influences the money supply. Those fluctuations in the money supply help set the interest rate. See the graph below for the
relationship.

The Fed has been relatively quiet and has not announced any plans at the moment to do any further monetary expansions as it is aware of the threat of inflation. Looking at the month to month trends in the CPI we see a downward trend going from 0.5% in July, 0.4% in August, 0.3% in September, -0.1% in October, and 0.0% in November. So we do not have any massive jumps in inflation at this point and with the Fed not planning any massive monetary shifts at the moment, we should be relatively safe. The graph below shows the growth rate of the money supply for the last two years and you can see that the growth rate of the money supply though still positive has slowed down substantially. Once we see sustained economic growth, the Fed will attempt to slow down even further the supply of money to raise the interest rate to stop inflation from running away.

GDP Growth

GDP is the measure of all final goods and services sold in the economy. GDP grew at 1.8% in the third quarter, up from 1.3% in the second quarter and 0.4% in the first quarter of 2011. Now, these are not great numbers to get excited about as the average quarterly growth rate for GDP over the last 50 years is 3.28%, which if you look at numbers for 2010, they were closer to the 3% mark each quarter. Right now high unemployment and a high degree of uncertainty (especially headed into an election year) is not helping. Personal consumption is down from a year ago 2.6% in the third quarter of 2010 to 1.7% in the third quarter of 2011. Being that consumer spending makes up the majority of the GDP, this is the reason for lower GDP growth during 2011. There is a high degree of uncertainty headed into 2012 with the possibility of a new president, fear of an ever growing national debt, and a heated political divide in Congress. I think that with this high degree of uncertainty 2012 will not be a very big year for economic growth as spending will not be very high as businesses and consumers wait to see what the next four years will bring. Regardless of who wins the presidential election, there will be a sense of stability for the next 4 years as it will give consumers and businesses an idea of what to expect for the next 4 years. But to keep an eye on what will happen to GDP, watch the personal consumption data, especially on durable goods. That will be a very big indicator for the direction of the economy. Another good statistic to watch is inventory levels. Inventory levels are a good leading indicator for the economy because when you see inventory levels starting to rise that means that businesses have sold what they had stored and they have increased production to fill the need to replenish the product. Right now we are seeing stagnant growth, but to better understand the future will be to better understand the statistics we see now.

Unemployment

We have seen unemployment fall from 9.1% in July to 8.5% in December. Though it is encouraging to see the unemployment rate fall slightly, 8.5% is still a very high number. It is difficult to say if this drop in the unemployment rate is due to seasonal hiring for the holiday season or if people continue to leave the labor force. The following graph shows labor force participation and you can see the decline in the last 2 years.

The key will be to see what the unemployment rate does in the first 2 months of 2012, if we see the decrease then that is a very positive sign for the economy and in turn could increase consumer spending and GDP, however if the unemployment rate rise then we know it was just seasonal workers. The big number to pay attention to is the week to week first time unemployment filings. This number is usually all over the place right now, but following the trends in it over time can give you an idea as to what job conditions are out there. This is a number you hear about quite often in the media and is very important in attempts to try to forecast future unemployment rates.

Following the statistics can help you better understand the economy, and though it is impossible to predict fully, these little things can help you better understand the day-to-day comings and goings in the economy.