U.S. Economy

The U.S. economy is a vast, amorphous, invisible network that permeates practically everything we do. Politicians love to trumpet what they've done to try to spur it on and workers worry about how it will effect paychecks and prices at Wal-Mart, but no one can actually see it, so we're left with something of a guessing game. How strong is the economy? Is it growing—or slowing? What can we do to make it healthier?

The most popular way to comprehend the economy is by tracking GDP, or gross domestic product, the final market value of all goods and services produced. The U.S. Bureau of Economic Analysis tallies the money Americans have spent, adds exports and subtracts imports, then publishes a number. Count up the Fords and Frappuccinos, the pedicures and dental work, and you've got GDP.

Government and business purchases are in there, but about 70% of it comes from consumer spending, which is why people get so worked up about measurements related to individuals' buying habits, like consumer confidence and the consumer price index. About half of that consumer spending comes from housing "rent"—economists' gauge of how much people spend on their homes, whether they're actually rented or owned.

Now, GDP isn't perfect. It doesn't, say, take into account the underground economy—black-market sales, wages paid off the books—which by some estimates is nearly a tenth the size of the aboveboard economy. Nonetheless, GDP is what we usually focus on. In the third quarter of 2006, for example, when seasonally adjusted annualized GDP came in at 2.0%—compared with 5.6% just two quarters earlier—it prompted chatter about an economic slowdown.

The government tries to control the economy in two ways. Fiscal policy adjusts government spending and taxes; monetary policy adjusts the amount of money in circulation. There are big (read: big) disagreements, both academic and political, about the extent to which tax breaks, for individuals and companies, stimulate the economy. There is consensus, on the other hand, about the role of monetary policy. It wasn't always so, but nowadays people generally agree that the economy can be successfully managed by giving control of certain interest rates to the Federal Reserve Board, the seven-member group that runs the government-chartered but operationally independent central bank.

The Fed, as it's called, employs hundreds of economists to project computer models of the economy—for the U.S. and the world—in order to figure out where we are in the economic cycle and how to keep growth chugging along. Popular gauges include the unemployment rate, worker productivity, housing starts and new home sales, business investment, manufacturing trends and producer and consumer prices.

All the statistics taken together, however, still only give a partial view of the economy. And many of those statistics are themselves open to interpretation. For instance, in recent years, how statisticians determine who is unemployed has been the root of much debate. For example, a person who is working only part-time when he would rather work full-time is counted as employed, even though he is what you might call underemployed—a state that isn't reflected in official figures.

These days, people watch as the Fed and its chairman, Ben Bernanke, try to orchestrate a "soft landing"—an incredibly delicate balancing act that would restrain inflation (a rise in prices) without stifling economic growth. The main method: controlling the amount of money in circulation and, in turn, interest rates.

The U.S. is more tied to the economies of other nations than ever before. Right now, the U.S. is running huge shortfalls in both the current account and the federal budget—the so-called twin deficits. The current account measures trade in goods and services and the flow of money among nations. Part of that is the trade deficit, which is the result of the U.S. importing a lot more than it exports. To balance out the equation, Americans, in the aggregate, either have to sell assets (stocks, real estate) or borrow money from abroad (by issuing Treasury bonds) to pay for the goods they buy. You might not see all that happen when you purchase a Samsung DVD player or a BMW sedan, but take your transaction, combine it with billions of others, and a picture of the globally entangled economy emerges.

That works just fine until other countries aren't willing to sell things in exchange for American assets. If foreigners suddenly stop buying U.S. debt or otherwise stop funding the trade imbalance, there could be a decline in the dollar and a surge in interest rates that might trigger a recession—one reason why people around the world keep such a close eye on the U.S. economy.

—Barbara Kiviat