South-Western College Publishing - Economics  
Mirror, Mirror on the Wall
Topic Output, Income, and the Price Level
Key Words Inflation, Economic Growth and Trade Deficit
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Reference ID: A166881697

News Story The economy has pulled out of a sharp winter slowdown and grew at a quicker pace during the second quarter. Consumers have been spending less, but that lower spending was more than made up for by foreign trade and investment spending by businesses.

The actual growth of the economy was put at 3.4 percent after accounting for inflation. Nevertheless, analysts are split on the future path the economy will take. Some think the economy is on the upswing and will continue while others see signs of deterioration and decline.

Edward P. Lazear, chairman of the White House Council of Economic Advisors, said the numbers where consistent with a recovering and robust economy. “We believe that the economy is back on track,” he told reporters in Washington.

On the Democratic side the interpretation was given in less optimistic terms. Senator Charles E. Schumer of New York called the report “a temporary oasis amidst too much bad economic news.”

An improvement in the trade deficit, stronger spending by both business and government, and a little less drag from the housing marked all tended to help economic growth in the spring quarter. The first quarter of the year produced only a 0.6 rate of growth, the slowest in more than four years, compared to the last quarter’s 3.4 percent.

Most economists think neither of those two numbers are reflective of the current trend, and suggest something in between the two is more realistic for the future. Economists generally feel that a growth rate of 3 percent represents a healthy economy and is a sustainable level of growth.

“It’s a little bit fanciful to get as excited about 3.4 as you were despondent about 0.6,” said Robert J. Barbera, the chief economist of ITG, an investment advisory firm. “Essentially over the first half of this year, and the second half of last year, the run rate of the economy is 2 percent and that’s soft.”

On the positive side is an argument that business did not increase their inventories significantly over the past few months, leaving room to increase stockpiles later in the year and help push the economy forward.

“Firms are entering the second half of the year with very lean inventories,” said Mr. Stephen Stanley, the chief economist of RBS Greenwich Capital. “That bodes well for continued gains in output.”

So, when the analysts look into their forecasting mirror to ask which direction the economy is going the answer are coming up different. The Republicans are going with the forecasts of growth and a strong economy while the Democrats are going with the prognostication of a slower economy. What else would you expect with an election just around the corner?

Discussion Questions:
1. Discuss the meaning of the statement where the economy grew “3.4 percent after accounting for inflation.”
2. Discuss why starting with low inventories in the second half of the year “bodes well for continued gains in output.”
Multiple Choice/True False Questions:
1. When business inventories are building:
  1. there is a negative effect on economic growth.
  2. inflation will definitely fall.
  3. economic growth is influenced positively.
  4. the Federal Reserve will try to stop it.
2. The federal funds rate is the interest rate:
  1. can not be trusted.
  2. is a “real” measure of growth.
  3. will have to be adjusted for price changes.
  4. None of the above.
Source Jeremy Peters, "Consumer Price Gauges Rise More Than Expected," The New York Times Online, February 22, 2007.
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