Economics 101: What does normal look like, economically speaking?
Is there a way to get a quick handle on whether a piece of data is good or bad?
Ok, so I’m flowing on with Dymphna’s Economics 101 course. A week or so ago I gave you a framework for placing all the different data that’s out there. Now let’s have a look at how we can quickly understand what a piece of data means.
Remember, this isn’t the be all and end all of investing. Too many people put too much emphasis on what the market is doing, and not enough focus on how a particular deal stacks up.
But still, if you want to be a complete-package investor, you need to have a handle on this stuff.
Ok, so the basic trick here is that most data points have a concept of “normal.”
That is, each time the data comes out, it tends to be around a certain amount, more or less.
Let’s take GDP for example, and let’s think about it the way economists usually think about it, in annual growth terms.
So typically, on average, GDP grows about 3-4% a year. So in any quarter (GDP data is published quarterly), that’s what you’d expect annual growth to come in at.
And so you might see something like, “GDP came in at 0.6% in the quarter, and 3.2% over the year.”
Those numbers are a bit meaningless to you unless you know what to expect. A result like that would be pretty average. If it was 0.9% in the quarter and 4.4% over the year, then you would know that that’s a good result.
If it was 0.2% in the quarter and 2.4% over the year, you’d know that that’s a pretty ordinary result.
And if it was negative in the quarter, then you’d know that’s an unusually bad result.
So this is the trick that economists and market watchers like me have in their back pocket.
We don’t know what the level of GDP is. I couldn’t even tell you. $1.4 trillion? Something like that?
But we don’t know because we don’t care. As I said a couple of weeks back too, we try to bring everything back into annual growth terms, because that makes it easy to compare apples and oranges.
So this is the trick. Look at the annual growth rates, and try to keep in your head what a ‘normal’ rate would be.
And what is ‘normal’? Well it depends on what data we’re talking about.
Let’s have a look at our headline indicators from the dashboard I introduced a little while back.
For GDP, as I said, in a mature economy like Australia’s, you want to be growing about 3-4% a year.
For the unemployment rate – well, this is the one exception I mentioned, where it’s expressed as a percentage. So we have this idea of ‘full employment’. At this level, there’s a certain amount of churn in the job market, but you can’t really push below it without over-heating your economy.
We kinda think about this full employment rate being something like 5%. So 5-7% is pretty normal, and anything above that being a bit of a worry.
For inflation – actually, let’s get clear on what this actually is first. So inflation keys off the consumer price index (CPI). The Australian Bureau of Statistics goes out and tracks the price of stuff, and then mashes it all into an index. That index is based to 100, so the index is like 180, 182… something like that.
But we don’t talk about the level. We talk about the annual growth rate. And the annual growth rate in the CPI has a specific term: inflation. So when we’re talking about inflation we’re talking about annual growth in the CPI.
And what’s normal? Well, the RBA has a mission to keep inflation between 2 and 3%, so that’s a good measure. However, in recent years, inflation has consistently under-shot the RBA’s target band, and has moved between 1.5% and 2%. So this is sort of normal, and when it breaks back above 2%, it’ll be big news.
What else have we got?
Well, there was the price of money – interest rates – but interest rates have just been heading south for over a decade now, so I think economists are actually giving up on the idea of a normal now. We’re in the middle of a paradigm shift.
Then there’s the (US dollar) exchange rate. Historically this has moved between about 50 cents and $1.10, but you can kinda think about 70 cents being normal. I do.
Finally, there’s property prices. This changes depending on where you are in the country. I would take a rough stab and say about 5% is close to ‘normal’.
Anything less than that is probably a bit disappointing, while anything north of 10% is exciting!
And a that’s kinda about it.
If you can remember our dashboard, and where these headline indicators fit on it, and if you can remember the ranges they normally move in, you’re most the way there.
This should give you the ability to make sense of most economists. It will give you the ability to talk like an economist.
(If that’s something you’ve ever aspired to…)