Economic Indicators: Gross Domestic Product(GDP) & Purchasing Manager’s Index (PMI) Index
What is Economic Indicator?
Economic indicators are used to measure the overall health and state of the economy. Government agencies typically issue them in the form of a census or survey. Investors care about them because they indicate the amount of systematic risk in the system, which affects the prices of securities and investments.
Economic Indicators #1: Gross Domestic Product
The primary economic indicator is the gross domestic product, which measures an economy’s total dollar value.
The value of an economy consists of four parts consumption investments that are made, net exports, and government expenditures
All combined, they give an overall view of the economy, and the change in the economy is measured as GDP growth, which could be very important for investors in terms of their outlook on the economy and the stock market.
GDP numbers are released once a quarter.
Let’s look at GDP in the United States in 2017, so you’re well-calibrated. It was $19.4 trillion in total value on a per person basis.
That equates to approximately $59,000 per American. The growth rate in 2017 compared to 2016 was 2.3%.
Economic Indicators #2: Purchasing Manager’s Index
What is the Purchasing Manager’s Index, PMI index?
Purchasing Managers Index (PMI Index) can be defined as a measure of the prevailing direction of economic trends in manufacturing. The PMI is based on a monthly survey of supply chain managers across a number of industries, covering both upstream and downstream activity
It is a significant economic indicator that looks at production levels, orders, inventory, and employment.
It shows expansion or contraction for manufacturing companies, with a reading above 50 indicating expansion and below 50 indicating contraction.
The scale is from 0 to 100.
The Consumer Price Index, or CPI, is a measure of inflation for an economy. It’s calculated by taking a basket price of goods and comparing it over a time period, typically a year.
In the United States, consumer price index inflation in 2017 was 2.1% compared to 2016.
Leading and Lagging Indicators.
Leading economic indicators tell us where the economy is headed in the future.
For example, the stock market typically looks forward at least 6 to 9 months about where the economy is headed, so you will see stock prices start to fall before GDP growth rates decline.
That’s an example of a forward-looking indicator.
By contrast, lagging indicators represent what’s happened in the past, so GDP growth rates are collected and take time to be processed.
When investors actually read the GDP numbers, they’re looking back at what happened last quarter or last year, so they are lagging indicators.
Investors care about both leading and lagging indicators when valuing companies and making investments.
Fiscal policy is the government’s budget policy. It relates to how the government changes its level of spending and the tax rates.
Fiscal policy is considered the sister to monetary policy, which are the two ways that the government monitors and influences the economy.
How Does Fiscal Policy Works?
Supporters of fiscal policy believe that the government can affect public spending, inflation, and employment by manipulating two key variables.
The first variable would be the level of spending, which is the amount of money that the government spends.
The second variable would be the tax rate, which is the amount of money that the government earns.
Essentially, the government is affecting inflation and employment by manipulating its own cash inflows and outflows.
Expansionary Fiscal Policy
Expansionary fiscal policy is used when the economy is slowing; the government reduces taxes and increases government spending.
In turn, this stimulates the economy, reducing unemployment and increasing the level of economic activity such a sales and production.
Contractionary Fiscal Policy
This is used when the government faces too much economic expansion, which in turn causes high inflation. To slow the economy down, the government imposes or raises taxes. This reduces income levels and causes consumption and investment to fall.
According to classical Keynesian economics, a reduction in taxes and increased government spending affect the economy in similar ways.
Conversely, an increase in taxes would equal a decrease in government spending. However, when actually faced with inflation and excess demand in the market, most governments tend to lower government spending instead of raising taxes, because raising taxes reduces the amount of support for the government.
Return on Investment (ROI) is a measure of performance used by analysts to evaluate how good and investments return is compared to the investment cost.
The formula for ROI is gained from investment minus the cost of investment all over the investment cost, times 100. The gain on the investment is equal to the money from the sale of an investment or the increase in the value of the investment, regardless of if you sold it or not.
Basically, if you bought a stock and its price went up, that would be a gain on investment.
Why do analysts use Return on Investment (ROI)?
- Return on Investment (ROI) is great for assessing an investment’s profitability and efficiency and making financial decisions.
- Return on Investment (ROI) is also relatively easy to calculate and widely applicable.
- Return on Investment (ROI) helps analysts determine which investment opportunities are better.
Return on Investment (ROI) is commonly miscalculated
For stocks, Investors usually fail to include transaction costs and dividend payouts into the R. O. I calculation
Investors tend to forget to incorporate rental income, taxes, insurance, and upkeep costs into the ROI calculation for real estate.
That being said, we want to emphasize that it’s incredibly important to account for all the costs and gains of the investment throughout its entire lifespan.
We can’t just take the ending value and divided it by the initial costs because we might miss some contributing factors.
The money market is a market of debt instruments with short-term maturity, meaning less than a year.
They exist to allow governments and banks, and large institutions to raise money by selling these money market securities to investors.
It also allows investors, which consists of individuals and large institutions, to invest their excess cash in a very low-risk way and earn some interest.
How the Money Market Actually Works?
Large corporations that need cash flow can borrow money by selling these securities or corporations with excess cash could be the investors as well.
Small companies can invest through mutual funds or through their bank, and individual investors can invest in the money market through their bank account or a mutual fund as well.
Type of Securities
- The government issues Treasury bills
- Banks issue certificates of deposit
- Corporations issue commercial paper.
- Banks can also create short term mortgage-backed securities
- Banks also issue a product called a banker’s acceptance that’s guaranteed by their bank.
- And finally, there are repurchase agreements, which are short forms of borrowing that evolved selling a security within an agreed-upon price that it will be repurchased in the future.
The Function of The Money Market.
It helps contribute to economic stability and development by providing liquidity into markets and into institutions.
- It helps with trade financing.
- It helps with Central Bank policy management.
- It helps with the growth of corporations and industries by allowing investment to flow through.
- And finally, it provides commercial banks with a market that they could directly invest in when they have excess reserves or borrow from if they need additional liquidity.
A commercial bank is a financial institution that grants loans to its customers. It can lend money by accepting deposits from other customers that it lends out to these clients.
How Do Bank Makes Money?
It gets funds from its customers and pays them a portion of interest on those funds.
It then lends out funds to other customers and charges them a rate of interest. The spread between the amount that it pays the deposit customers and the amount that it charges the borrowing customers is the spread and the money that it makes, called interest income.
This is the main way banks make money. They also charge fees such as convenience fees or transaction fees that allow them to earn money as well.
Functions That a Commercial Bank Provides.
They accept deposits in the form of saving accounts, current accounts, or term deposits. That means they take money from the customers that want to store it and earn some interest.
Commercial banks create credit facilities, short-term and medium-term loans that customers can use the money to, then invest in for other purposes.
They have credit creation, which arises from deposit accounts, which borrowers draw funds from.
And they also sort of essential agency functions for their customers, which includes paying checks and dividends and insurance and trading accounts for investments and other securities.
Type of Loans Offered by Commercial Banks.
There’s a standard bank loan where the amount of money offered by a bank to the borrower has a defined interest rate and a fixed period of time.
There’s cash credit where the bank lends client money to go be on their account limit.
There’s a bank overdraft where the client can actually extend for a certain period of time beyond the limit of their account.
Finally, credit cards or a form of spending where customers can purchase goods or services and pay for them later with the actual cash in their accounts.
Central banks regulate commercial banks, and other government organizations that require the commercial banks to operate were in specific rules and limits.
This includes capital reserves that help the bank prevent insolvency or bank runs, which means they would run out of cash and not be able to pay back their customers.
In summary, a commercial bank’s main function is to accept deposits and lend money out to individuals and companies that need that cash to grow the economy.