Six key variables

• You can get a very good idea of the pulse of economic activity by looking at only six key economic variables: six variables that together give a very large chunk of the significant information about the macroeconomy. These six variables are:
  • Real Gross Domestic Product
  • The unemployment rate
  • The inflation rate
  • The interest rate
  • The level of the stock market
  • The exchange rate.

Real GDP

• The first key quantity is the level of real Gross Domestic Product, called "real GDP" for short, and often referred to as just "GDP."
• Let's unpack the definition of real GDP word-by-word.
• Real GDP divided by the number of workers in the economy is our best readily-available index of the status of the economy: how well the economy is doing as a social mechanism for producing goods and services that people find useful: the necessities, conveniences, and luxuries of life.

U.S. Real GDP per Worker Measured at 1995 prices, all economic forecasts are that U.S. real GDP per worker--the total value of all final goods and services produced in the United States, divided by the number of workers in the labor force--will kiss $60,000 in the year 2000. This marks more than a quadrupling of real material standards of living since 1900, when real GDP per worker at 1995 prices was some $13,000 according to standard estimates. Other features of macroeconomic history are visible on the graph below--the Great Depression of the 1930s, the World War II boom, the period of stagnation following the 1973 OPEC oil price increase punctuated by the 1974-75 and the 1980-82 recessions--but there is no doubt that the principal event of the twentieth century was the more-than-quadrupling of real GDP per worker. Source: Angus Maddison (1995), Monitoring the World Economy (Paris: OECD), as extended.

The Unemployment Rate

• The second key quantity is the unemployment rate.
• The unemployed are all people looking actively looking for jobs who have not yet found one (or not yet found one that they find attractive enough to take rather than continue to look for a better).
• The number of unemployed divided by the total labor force--the unemployed plus those people at work--is the unemployment rate.
• In the United States every month the Labor Department's Bureau of Labor Statistics conducts the Current Population Survey: a random survey of America's households. The estimated of unemployed from the survey is then divided by the estimated labor force from the survey, and the result is that month's unemployment rate. Last month's unemployment rate is usually the biggest single piece of economic news when it is released, on the first Friday of every month.
• An economy with no unemployment would not be a good economy. Just as an economy needs inventories of goods--goods in transit, goods in processes, goods in warehouses and sitting on store shelves--in order to function smoothly, so an economy needs "inventories" of jobs-looking-for-workers ("vacancies") and of workers-looking-for-jobs ("the unemployed"). An economy in which each business grabbed the first person who came in the door to fill a newly-open job and in which each worker went and took the job associated with the first help-wanted sign that he or she saw would be a less productive economy.
• We want workers to be somewhat choosy about what jobs they take--to be willing to think that "this job pays too little", or "this job would be too unpleasant", or "when the employers find out how unqualified I am to do this they will be very unhappy." We want employers to be somewhat choosy about which workesr they hire. Such frictional unemployment is an inevitable part of any process that will make good matches between workers and firms--match workers qualified to do jobs with jobs that use their qualifications.
• But there are recessions, and depressions, during which unemployment is definitely not "frictional." The market economy's matching of the supply of workers willing and able to work with businesses that could put their skills and labor-power to making useful goods and services breaks down. In the United States and in Germany during the Great Depression the share of workers unemployed rose to between one-quarter and one-third: between twenty-five and thirty percent.
• The unemployment rate is perhaps the best indicator of how well the economy is living up to the potential created by the current level of technology and the current stock of productive capital.

U.S. Unemployment in the Twentieth Century The unemployment rate in the United States has dipped as low as one and a half percent during World War II and as high as twenty-five percent during the Great Depression--the principal macroeconomic catastrophe of the past century. No other recession or depression--not even the depression of the early 1890s--comes close to the Great Depression. Since World War II, the U.S. unemployment rate has fluctuated between three and ten percent, with the decades of the 1970s and 1980s seeing relatively high rates of unemployment. Source: Author's calculations from Economic Report of the President and from Romer.

The Inflation Rate

• The third key quantity is the inflation rate: a measure of how fast the overall level of money prices is rising. If the inflation rate this year is five percent, that means that this year things-in-general cost five percent more--in money terms, in terms of the symbols printed on dollar bills, not in sweat or toil.
• A very high inflation rate--more than twenty percent a month, say--can cause massive economic destruction, as the price system breaks down and the possibility of using profit-and-loss to make rational decisions about what should be produced vanishes. Such hyperinflations are one of the worst economic disasters that can befall an economy.
• Moderate inflation rates--more than ten percent a year, say--are very unsettling to consumers and to business managers. This leaves economists scratching their heads to some degree: moderate rates of inflation should not do too much damage to consumers' investors' and managers' ability to figure out what the best use of their financial resources is. Yet all such groups appear strongly averse to inflation, and they vote: politicians in the industrialized economies have learned over the past generation that expressing a lack of commitment to low and stable inflation gets them a quick ticket out of office.

Source: Author's calculations from Economic Report of the President and Historical Statistics of the United States.  

The Interest Rate

• The fourth key quantity is the interest rate. Economists speak of "the" interest rate because different interest rates move up or down together. But in actual fact there are a very large number of different interest rates, applying to loans that mature at different times in the future, and to loans of different degrees of risk.
• Those people or business enterprises who think that they could make good use of additional financial resources now borrow. Those business enterprises or people who have no sufficiently productive or utilitarian use for their financial resources today lend.
• When interest rates are low--money is "cheap"--investment tends to be high, because businesses find that even less-profitable investments will still generate the cash flow needed to pay the interest and repay the principal sum borrowed.

Real Interest Rates Interest rates on long-term debt--like the ten-year notes issued by the U.S. Treasury--are almost always higher than interest rates on short-term debt instruments like the three-month Treasury Bills issued by the U.S. Treasury. Interest rates have fluctuated widely in the U.S. since 1960. Real interest rates--that is, interest rates adjusted for inflation--have even been negative. During the 1970s nominal--money--interest rates were so low and inflation so high that the interest and principal on a short-term loan bought fewer commodities when the loan was repaid than the original loaned-out principal had purchased when the loan was originally made. Interest rates in the United States increased radically in the early 1980s--the Volcker disinflation again--and have not yet returned to their levels of the 1950s and 1960s. Source: Author's calculations from Economic Report of the President and Historical Statistics of the United States.

The Stock Market

• The level of the stock market is the key economic quantity that you likely hear about most--you most likely hear about it every single day on the news. The level of the stock market is an index of expectations of how bright the economic future is likely to be. When the stock market is high, average opinion expects economic growth to be rapid, profits high, and unemployment relatively low in the future. (Note, however, that there is a certain mirror-like and tail-chasing element in the stock market: perhaps it would be better to say that the stock market is high when average opinion expects that average opinion will expect that economic growth will be rapid in the future.) When the stock market is low, average opinion expects the economic future to be relatively gloomy.

The Stock Market Over the past century, on average a share of stock has traded for about fifteen times its "trailing" earnings per share--the profits of the corporation in the previous year, divided by the number of shares of stock the corporation has outstanding. But companies with good prospects for growth sell for more than fifteen times their earnings, and corporations seen as in decline sell for less.   Source: Author's calculations from Economic Report of the President and Historical Statistics of the United States.

The Exchange Rate

• The exchange rate governs the terms on which international trade and international investment takes place.
• When the dollar is appreciated, the value of the dollar in terms of other currencies is high: this means that foreign-produced goods are relatively cheap to American buyers, but that American-made goods are relatively expensive for foreigners. When the dollar has depreciated the opposite is the case: American goods are cheap to foreign buyers--thus exports from America are likely to be high or at least about to rise--but Americans' power to purchase foreign-made goods is limited.