Economic growth is generally measured by gross domestic product (GDP) or gross national product (GNP). GDP measures all goods and services produced within the country’s borders and is more commonly utilized by economists to measure economic strength. GNP measures all goods and services produced by residents of a country, including those produced outside of the country (e.g. goods sold by a US citizen while they temporarily live in Spain). GDP and GNP are both measured in constant dollars; this means the data reported are inflation-adjusted. That way, economists can compare the economic output of different time periods easily
If GDP is rising, more goods and services are being created and sold in the United States. Essentially, if GDP is positive, we’re experiencing economic growth. The higher it is, the faster the economy is growing.
If GDP is falling, fewer goods and services are being created and sold. If GDP is negative, the economy is shrinking. When this occurs for long periods of time, the economy can fall into a recession or depression. A recession is two quarters (six months) of GDP decline, while a depression is six quarters (a year and a half) of GDP decline.
Our US economy goes through a pattern of cycles over time. Sometimes the economy expands, unemployment levels are low, and consumer confidence is high. When GDP rises, it reflects an expansionary or expanding economy.
A low-interest rate environment and tax-friendly laws help create and continue this cycle. When money is easy to obtain in terms of borrowing or through employment, people and businesses tend to spend that money, which grows the economy.
No good thing lasts forever, though. Eventually, the economy will peak, although knowing when this will happen is difficult to pinpoint. Excluding the economic downturn due to COVID, the US economy has been expanding essentially since the end of the Great Recession, starting around mid-2009. There have been signals of an upcoming recession that have not yet materialized, but the economy continues to grow.
Pinpointing the exact moment of an economic peak isn’t possible until we pass it and reflect. Even if there is short-term economic turbulence, the economy can always turn around before heading toward a recession. Generally speaking, an economic peak typically involves the following:
Low interest rates
High GDP/GNP levels
Low unemployment levels
Eventually, the economy will recede (shrink), no matter how much the government (including the Federal Reserve*, the US central bank) may try to prevent it. As we’ve discussed, a recession occurs when GDP levels fall for two straight quarters (6 months). In some cases, this can be due to a “bubble” in a specific sector. For example, the US housing bubble contributed to the Great Recession. Real estate prices rose significantly (inflation); to reduce inflation, the Federal Reserve raised interest rates, which in turn reduced economic activity.
*While the Federal Reserve and monetary policy is an important topic for the SIE exam, it is unlikely you’ll encounter any specific Series 7 test questions on these concepts. For context, the Fed controls the money supply with two goals in mind - economic growth and manageable inflation levels.
When interest rates rise, less money is borrowed, leading to less money being spent. With less money being made across the economy (for people and businesses), unemployment rises as many workers are laid off, which in turn reigns in overall spending. Eventually, rising interest rates stabilize prices and reduce inflation, but the economy shrinks in the meantime.
At a certain point, the economy “bottoms out” at the trough. This is when the economy reaches its lowest point, but it’s difficult to pinpoint when this will occur (like it’s difficult to pinpoint an economic peak).
Generally speaking, an economic trough typically involves the following:
High interest rates
Low GDP/GNP levels
High unemployment levels
If no good thing lasts forever, neither does a bad thing. The economy will bounce back at some point in time (or, at least it always has). After prices stabilize, the Federal Reserve expands the economy by loosening the money supply. They’ll inject more money into the system, making it easier for all to borrow money at cheaper rates.
The economy starts to recover when GDP levels begin rising again, signaling an expanding economy. Job openings become abundant again, consumer confidence begins to rise, and spending starts to accelerate. Recovery and expansion are essentially the same; however, recovery occurs after an economic recession.
To summarize, economies tend to follow these cycles over time. We typically see the cycles fall in this order:
