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Recognizing Economic Trends: The Basics

Many factors influence the economy, including the government’s fiscal policy and the monetary policies followed by the Federal Reserve System. In turn, the economy affects many aspects of your life – from how much you earn, to what you pay for a bag of groceries, to the interest rate you pay on your credit card.

Understanding how to read economic indicators is critical if you want to get an idea of where the economy may be heading in coming months.

Take a look at some common economic indicators reported in the media.

Gross Domestic Product (GDP). GDP measures the output of the economy and it gives an indication of where the economy may be heading. GDP includes spending by consumers, businesses, and governments as well as net exports (exports minus imports). When the economy is growing, there are usually more jobs, people have higher incomes, and businesses earn greater profits. Although growth in GDP is usually positive, too much growth can mean shortages of goods and workers, which can cause inflation to increase.

Consumer Price Index (CPI). The CPI tracks the prices of a wide range of goods and services, including food, housing, transportation, health care, and clothing. An upward trend is one of the clearest indications of inflation. Changes in the CPI can affect Social Security payments, federal income taxes, labor and rental contracts, and the value of fixed-interest investments.

Personal income and spending. Personal income directly influences consumer spending. It includes hourly wages and salaries earned by workers, Social Security payments, pensions, and interest and dividends from investments.

Consumer confidence. Consumers’ attitudes – how willing people are to spend their money – are important economic indicators. High consumer confidence is considered an indication of likely continued economic growth.

Productivity. Productivity measures the goods and services that a business can produce per hour of work. Productivity increases when companies can produce more without adding more resources. Higher productivity is ordinarily considered good news for financial markets because it means that businesses can increase profits or wages for workers without having to increase prices.

Unemployment. The unemployment rate is the percentage of people actively looking for jobs. It includes people who have lost their jobs and are looking for new ones as well as people entering the workforce. Rising unemployment generally means a slowing economy. Very low unemployment becomes a problem if employers must increase wages and benefits to attract workers, thus forcing up costs and raising inflation.

Jobless claims. This report tracks the number of people who have lost their jobs and applied to their states to receive unemployment compensation. It can signal future changes in employment trends and the economy.

The Economy and Your Investments
The stock market frequently reacts to even the slightest bit of economic news. But it doesn’t mean that you have to. When it comes to investing for your long-term financial goals – such as retirement – your decisions should be based on your time horizon, goals, and risk tolerance, not on short-term market movements.

Investment decisions based on short-term market fluctuations are usually emotional reactions, which often lead to disappointing results. Instead, build a portfolio of diversified investments, review it regularly, and make changes only when your financial goals or circumstances change.

Want to Know More?
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© 2004 The Vanguard Group, Inc. All rights reserved. Used with permission.