Economic Growth Trends

Envision a very tall roller coaster, with its terrifying drops and steep climbs. The roller coaster you're thinking of is a great metaphor for the overall economic cycle, which also goes up and down. The economic cycle is different from economic trends, though, which don't play out with quite the same up and down movement but are still related to economic growth. What do you think distinguishes economic trends from economic cycles?

That's exactly right. Economic trends play out over the long term, so there's not that constant up and down movement like with the economic cycle. It would be a pretty boring roller coaster ride. That said, long-term economic trends can feed into the economic cycle, so they're important to understand, especially the economic growth trend. The __economic growth trend__ is the long-term growth path of GDP, or the average growth rate at which the economy cycles.

No. Economic trends aren't short-term factors.

Not exactly. The economic cycle and business cycle are the same; that's not a difference. The frequency of the economic cycle and economic trends is different.

Keeping in mind the long-term nature of economic trends, if the trend is an average over long periods, which do you think would be easier to forecast?

You got it. Trends are easier to forecast because they're long-term averages, while cycles are more frequent. That's why economic growth trends are typically thought to remain stable over time, with emerging market economies having higher trends of growth due to various positive factors, and developed economies having declining or lower growth trends due to negative factors. In fact, trends can actually build on each other. For example, the economic growth trend has many variables, such as population growth, demographics, business investment and productivity, government policies, inflation/deflation, and credit health.

That's not it. Cycles aren't easier to forecast. The length of time makes variables hard to predict

Well, no. The time frame varies, so one forecast is easier than the other.

Together these variables are important for setting the economic growth trend and, ultimately, capital market expectations. Under the discounted cash flow model, a higher rate of growth would probably offer investors a better expected return. Plus, there's also the benefit of a higher economic growth trend in the economy versus the effects of the business cycle and purchasing power. If a country has a higher economic growth trend, how will that impact investors?

No. If the economic growth trend is higher than average, there's limited risk of deflation anyway. So that's not a real benefit.

Indeed. If a country has a higher economic growth trend, then it can grow faster prior to reaching a stage of inflationary pressures. So investors benefit by earning higher real returns. As an analyst, you'll want to pay attention to the underlying variables that influence the economic growth trend. In particular, you'll need to focus on consumer trends because consumer spending is the largest source of economic growth.

Not quite. Higher inflationary growth rates imply that part of the return is lost due to increasing inflation, so that's not a benefit.

Really, that's not surprising, as consumer spending drives the business cycle. What is surprising is that over the business cycle, consumption is quite stable. This can be explained by the __permanent income hypothesis__, which states that consumers base their spending behavior on their long-run income expectations. Basically, consumers base spending on their perceived long-term income, practically disregarding unexpected events like winning the lottery or temporary income reductions. But when the economy is expanding rapidly and incomes are increasing, what do you think spending rates are doing?

No. Income expectations would probably increase during an expansionary phase.

No, actually. Spending trends don't increase at the same rate as income. If spending remains relativity stable, then some consumers will be taking that extra income and paying off debt.

Absolutely. Spending rates increase less than income increases because some consumers will build back savings or pay down debt during the expansionary phase. So overall income remains relatively stable. Similarly, if the economy tanks, consumption will only fall a small percentage and rebound quickly as consumers use debt to finance spending.

In summary: [[summary]]

Trends reflect a smooth economic path over the long term

Trends reflect super short-term factors that influence economic cycles

Trends capture the same frequency of the business cycle, but not the economic cycle

Cycles

Trends

They're equally difficult to forecast

Limited risk of deflation

Faster growth prior to inflation

Higher inflationary growth rates

Remaining flat

Increasing at the same percentage

Increasing at a lower rate than incomes

Continue

Continue

Continue

Continue