Become a better investor
Lesson in Course: Ambition reviews (beginner, 4min )
Part 3 of Invest with purpose
The gross domestic product or GDP provides us a current snapshot of our economic health. It takes account of all of the transactions that produce goods and services in a country within a specific time frame. GDP is reported quarterly and summarized yearly by the BEA (Bureau of Economic Analysis) in the US.
We can break the economy's health into four phases that occur in cycles, with one phase following another. The four phases are: expansion, peak, contraction, and trough and are collectively known as the business cycle. While the concept is straightforward, economists, investors, and people use varying terminology to describe this cycle.
Let's visualize the cycle first and then reconcile the differences in terminology.
Policymakers and investors keep a close eye on the state of the current economy. While the economy is not the same as the stock market, understanding the stages of the economy helps us effectively manage our risk. We've already previously learned that GDP serves as a scorecard or snapshot of the current economic health. Apart from GDP, there are other key indicators to the economy. These indicators include unemployment, manufacturing activity, new homes purchased, new construction, inflation, and consumer confidence.
These indicators all help provide an overall view of the economy and shouldn't really stand on their own. To better understand, we can break these indicators down further into groups of leading indicators, lagging indicators, and coincident indicators.
The Federal Reserve can increase or decrease the money supply via two methods. First, the Fed can change interest rates, or the Fed can print physical dollar bills. Although it's easy for us to connect printing with more money supply, interest rates are a little less straightforward.
To help us understand, we need to know what creates our money supply. Cash, or physical money, is one-half of the money supply, while credit makes up the other half. In addition, credit is affected directly by interest rates—higher interest rates reduce the amount of credit. In comparison, lower interest rates (quantitative easing) increases the amount of credit and money supply.
The central bank of the United States, or the Federal Reserve, is one of two economic policymakers. The Federal Reserve makes decisions and changes to the monetary policy to increase or decrease the money supply. These policies directly affect financial institutions only. At this point, we need the Federal Government to step in and distribute the increased money supply to consumers or the economy. The Federal Government decides our fiscal policies or policies that target the spending or distribution of money into an economy.