INTRODUCTION
Economy/economic growth has great relevance and significance for a contemporary state, as it gives 1) capacity to deliver obligations and 2) ensures progress/stability (political-economic-social) (Intelligent Economist). For instance, when an economy expands (growing), it not only produces employment (one of the primary concerns of a state/government), but also it produces revenue for government (through various kinds of taxes), which allows a state to deliver its obligations, such as protecting citizens from foreign aggressors (national defense), providing healthcare and producing new lucrative socio-economic opportunities (Lalley).Studies reveal that countries with healthy economies can influence international developments with great ease. It is because economic progress translates into the increased and refined military and diplomatic strength (Heywood 108). One such example is of China, which economy has performed exceptionally in last two decades. As the economy of China improved, China’s war-machine not only grew but also modernized. Simultaneously, China’s sphere of influence also expanded, which allowed China to influence various kinds of strategic and economic outcomes both on regional and international levels (Koesterich). For these reasons, a state is very sensitive regarding the economy and its growth and its devices and implements various kinds of strategies to keep economic growth stable.
The inward effect, of economic growth or the healthy / stable economy, is 1) high employment level and 2) social-political progress. For instance, when the economy grows and its industrializes, it produces various kinds of economic and corporate opportunities (lucrative), which are exploited by individuals and firms (Piatkowski 90). When a system (political-economic) is not producing such opportunities, it begins to destabilize, which creates various sorts of challenges. Therefore, governments and state institutions (such as a central bank) use different instruments and tools (Fiscal and Monetary) to realize the objective of higher stable economic growth that facilitates them in realizing primary socioeconomic and political-economic objectives (Piatkowski 92).
GROSS DOMESTIC PRODUCT (GDP)
Gross Domestic Product, which is the monetary value of all final goods and services produced in a year, is the most common method of measuring and scrutinizing health of an economy. Economists prefer GDP because of its simplicity and ability to produce accurate results (almost accurate). There are different types of Gross Domestic Product; for instance, Nominal GDP, Real GDP, and GDP per Capita.
Nominal GDP: Nominal GDP is also monetary value of all final goods and services that are produced in a year by the economy; however, nominal GDP is not inflation adjusted, and for that reason it is misleading. However, it is still used by economists for different reasons.
Real GDP: On the other hand, Real GDP is the monetary value of all goods and services that are produced in a year; however, Real GDP is inflation adjusted, and it constructs quite an accurate image of an economy. Therefore, when the health of an economy is to be understood, Real GDP is studied.
GDP per Capita: GDP per Capital is the total output (GDP) divided by a total number of populations. It is a very simple method to understand how prosperous citizens of a country are (higher the GDP per Capita more prosperous they are); however, economists consider GDP per Capita misleading, as it does not provide detailed information regarding the distribution of wealth and prosperity in a country.
SELECTED COUNTRY AND ECONOMETRIC ANALYSIS
A country, which we have selected for this research exercise, is the United States. It is the largest economy in the world, which size is $20.4 trillion. The economy, of the United States, is so large that any fluctuations in its affect global financial and goods markets. Therefore, studying American economy, in detail, is essential. To understand American economy, we need to understand what affects the American economy. In other words, we will be studying how different economic factors (variables) affect GDP of United States. For that purpose, we will have to identify different variables that affect GDP. Once we identify and isolate these variables, we will retrieve data about these variables (will prefer government statistics) (International Monetary Fund).
The retrieved data will be imported to GRETL, open-source econometric software, where will perform OSL estimation on selected variables. Our dependent variable will be GDP, and through the scrutiny of literature, we will select independent variables.
LITERATURE REVIEW
Studies, about GDP, reveal that various factors affect GDP in the short and long run. For instance, investment is a factor, which directly affects GDP growth. For instance, when in an economy size of the domestic and international investment, employment and consumption rates also increase. Therefore, investment is used as an instrument to improve GDP growth.
We learn that the investment is itself a function of interest rate, which implies that changes in interest rate bring changes in investment. However, the relationship between interest rate and investment is negative, which means that when the interest rate decreases, investment increases and when interest rate increases, the size of investment decreases in an economy. As the central bank of a country (in case of the United States it is Federal Reserve), sets interest rates (through expansionary/contractionary monetary policy); therefore, interest rates are the central bank’s tool to bring changes in the economy (especially in the short run) (Asiedu 66).
In the United States too, economy primarily relies on expansionary and contractionary monetary policies of the Federal Reserve to bring changes in the economy. For instance, the Federal Reserve was the first line of defense against 2007-8 economic recessions, which jolted the American economy very badly. During this period, Federal Reserve employed expansionary monetary policy (increased money supply and reduced interest rates) to intensify economic activity in the United States’ economy. Increase in inflation aimed to increase consumption and producer’s incentive (in the short run), whereas the lowering of interest rate aimed to increase the size of investment in the US economy. The policy produced mixed results during the recessionary period; however, it kept the government from using fiscal instruments aggressively, which creates complications such as crowding-out effect (Lustig).
Employment is another variable, which is associated with GDP. The majority of the studies have inferred that GDP affects employment and vice versa; when an economy expands, employment rate also increases, and when economic growth dwindles, size of employment rate also dwindles. Another assertion is that with the increase in employment, the economy expands (economic growth), which suggests that there is a positive correlation between GDP and employment (Koesterich).
Employment is an end and GDP is a mean. Governments, around the world, focus on economic growth to increase the employment rate in an economy. For that purpose, government and its institutions use fiscal and monetary policies to realize the objective. During the 1929 depression, dubbed as The Great Depression, US government introduced and used the fiscal instrument to increase employment and thus the size of consumption in an economy. During other recessionary periods too, when employment and GDP growth decreased (abnormal), US governments of that time and Federal Reserve employed aggressive/expansionary monetary and fiscal policy.
Evidence, which suggests that the stock market has a positive correlation with GDP growth, is strong. However, the evidence about the positive correlation that runs from Stock index of GDP is ambiguous. It implies that GDP affects the performance of the stock market; however, we cannot say that for certain that GDP is affected by the performance of the stock market. Also, stock markets provide information (rudimentary and limited) regarding the health of the economy; the same cannot be said about GDP (Halcoussis).
Economic Cycles are an attribute of the Capitalist economy. During the boom, the economy expands at an exceptional rate; whereas, during recessionary period economic activity dulls down. For instance, during the 2007/8 economic recession, economic activities slowed to the extent that it pushed the unemployment rate to almost 11%. During this period size of investment also decreased to the worrying level, which compelled the government (Bush and Obama Administration) and Federal Reserve to take extraordinary measures.
Some studies claim that these cycles are periodic as after a certain period, rate consumption, in an economy, decreases. Since consumption is considered an engine of economic growth; therefore, when the rate of consumption declines, so does the economic growth. However, it is also a fact that there is no substantial statistical evidence to endorse the argument that consumption declines in intervals and causes economic recessions. Those, who oppose this argument, assert that as population size increases at a steady rate, so does the consumption. Consumption is only affected by perceptions, taste/preference, and employment rate.
It is believed that Foreign Direct Investment (inflows) has a positive impact on the economy. However, there is substantial evidence in favor of this claim. In the 1990s, after the collapse of the Soviet Union, many economies amended their economic systems (introduced economic reforms) to attract foreign investment. In many labor-intensive economies, foreign firms invested, which brought some changes to these economies (Veganzones‐Varoudakis and Sekkat 615). One such example is China, where foreign investment, in particular sectors of the economy, brought massive changes in the overall economy (Spillover effect) (Rupert and Solomon 124). However, studies reveal that spillover effect, of GDP, is very small in most of the countries and there is no credible proof about the expansion of the economy due to foreign direct inflows. Therefore, FDI inflows remain a controversial subject as there is no evidence to endorse the claim that FDI inflows affect the quality and quantity of an economy (Asiedu 71).
The methodical scrutiny of literature, about FDI, suggests that most of the foreign direct investment lands in Research and Development sector of the United States (Du, Lu and Tao 99). However, in developing countries, most of the FDI lands in the manufacturing sector, which examples are China, India, Mexico, and Bangladesh (Lustig).
The population is another factor, which directly influences consumption and thus the economy. For instance, when the size of the population increases, consumption naturally increases, this in return increases prices. Increase in price acts as an incentive for producers, which then increase their supply to meet the demand that has shifted to the right. However, in some countries, the increase in the size of the population has reduced (in few depopulations has occurred), which again suggests that size of consumption is on the decline (especially in developing countries).
SELECTED VARIABLES (INDEPENDENT)
The systematic and methodical scrutiny of the literature has allowed us to identify and isolate those variables that affect the economy or GDP growth. These variables are;
Unemployment Rate (UR) (percent): We have discussed in detail how GDP affects employment rate. However, in this academic/research exercise, we will attempt to learn how employment affects GDP.
- The volatility of the Stock Exchange (VIXCLS) Percentage change: Studies suggest that fluctuations in GDP growth directly and strongly affect financial and stock markets. Our objective is to learn how changes in the stock market affect the American economy (GDP).
- Fund Rates/Interest Rates (R-Rates) Percent: Interest rate has a negative correlation with investment, which implies that interest rates affect GDP. By conducting statistical analysis, we will try to learn that size of the impact of interest rates on the American economy (GDP).
- Inflation Rate: Inflation rate affects consumption and investment in the short run, which is why it’s a relevant variable for this academic study/research. (Note: We have changed Consumer Price Index (percentage change from previous year) to quarterly and average to obtain inflation rate).
- Private Domestic Investment (PDI) percentage change from previous year: Private Direct Investment is of one of the main components of economic growth; therefore, we have selected this factor/variable. The relationship between Private Domestic Investment and GDP is positive (Hussain).
- Recession (0= no; 1= yes): During the recessions, economic activity slows down abnormally; therefore, Recession has a negative relationship with GDP. We intend to learn the size of the impact of the recession in the American
There are various other variables, such as personal income, tax policy, and foreign direct investment, which affect the economic growth of a country. However, to keep our model stable and free of Autocorrelation and heteroskedasticity, we have selected above mentioned variables. The objective is not just to run the OLS estimation, but rather produce valid outcomes from OLS estimations.
DATA AND GRETL (STATISTICAL ANALYSIS SOFTWARE)
We have retrieved data from FRED (Federal Reserve Bank of ST. Louis), which is why the data has relevance (validated data). A detailed description of data and datasets are available in CSV/Excel files. The software, which we have used for the analysis is GRETL, an open source software.
The length of data is 60 Quarters (number of observations), and total variables are seven (7), including dependent variable. After applying multivariate regression test, we have also forecasted the missiles values of new two quarters. (Note: We retrieved/downloaded the data in CSV format).
Table Related To the Selected Variables (Quarterly)
| DATE | UR | GDP | R-Rate | Inflation Rate | PDI | VIXCLS | Recession |
| 01/01/2002 | 5.803405 | 3.7 | 1.723077 | 1.47594 | -3.60943 | 21.36083 | 0 |
| 01/04/2002 | 5.900441 | 2.2 | 1.751538 | 1.67456 | -2.28997 | 21.64313 | 0 |
| 01/07/2002 | 5.773022 | 2 | 1.738462 | 1.90904 | -0.53559 | 35.06844 | 0 |
| 01/10/2002 | 5.934484 | 0.3 | 1.478462 | 1.7462 | 4.40904 | 30.72672 | 0 |
| 01/01/2003 | 5.954452 | 2.1 | 1.243846 | 1.70371 | 1.66599 | 30.02262 | 0 |
| 01/04/2003 | 6.21217 | 3.8 | 1.253846 | 1.47836 | 1.18512 | 21.53127 | 0 |
| 01/07/2003 | 6.141405 | 6.9 | 1.021538 | 1.36548 | 4.77737 | 19.32016 | 0 |
| 01/10/2003 | 5.933037 | 4.8 | 1 | 1.36793 | 8.66803 | 17.42719 | 0 |
| 01/01/2004 | 5.774003 | 2.3 | 1.002308 | 1.66953 | 7.81675 | 16.65806 | 0 |
| 01/04/2004 | 5.641825 | 3 | 1.012308 | 1.9163 | 11.0863 | 16.23016 | 0 |
| 01/07/2004 | 5.478091 | 3.7 | 1.424615 | 1.97207 | 8.94448 | 15.44219 | 0 |
| 01/10/2004 | 5.477908 | 3.5 | 1.946154 | 2.09252 | 7.35452 | 13.65125 | 0 |
| 01/01/2005 | 5.332825 | 4.3 | 2.456154 | 2.19047 | 10.34699 | 12.78705 | 0 |
| 01/04/2005 | 5.170419 | 2.1 | 2.936154 | 2.11692 | 5.18376 | 13.40734 | 0 |
| 01/07/2005 | 5.026309 | 3.4 | 3.448462 | 2.07095 | 4.66599 | 12.25078 | 0 |
| 01/10/2005 | 5.01794 | 2.3 | 3.972308 | 2.25966 | 5.67521 | 12.78175 | 0 |
| 01/01/2006 | 4.790545 | 4.9 | 4.434615 | 2.12939 | 4.10857 | 12.04242 | 0 |
| 01/04/2006 | 4.738635 | 1.2 | 4.903846 | 2.27089 | 4.75984 | 14.52873 | 0 |
| 01/07/2006 | 4.698427 | 0.4 | 5.238462 | 2.39502 | 2.6238 | 13.60794 | 0 |
| 01/10/2006 | 4.511002 | 3.2 | 5.247692 | 2.15838 | -2.7253 | 11.03492 | 0 |
| 01/01/2007 | 4.57509 | 0.2 | 5.251538 | 2.36207 | -4.87767 | 12.56361 | 0 |
| 01/04/2007 | 4.557587 | 3.1 | 5.252308 | 2.03652 | -2.93986 | 13.7319 | 0 |
| 01/07/2007 | 4.713078 | 2.7 | 5.098462 | 1.98988 | -2.54737 | 21.58921 | 0 |
| 01/10/2007 | 4.858574 | 1.4 | 4.537692 | 2.24821 | -2.17121 | 22.02984 | 1 |
| 01/01/2008 | 5.010319 | -2.7 | 3.272308 | 2.11243 | -4.58797 | 26.12016 | 1 |
| 01/04/2008 | 5.407708 | 2 | 2.09 | 2.26629 | -7.55513 | 20.67297 | 1 |
| 01/07/2008 | 6.10351 | -1.9 | 1.99 | 2.22566 | -9.56861 | 25.07328 | 1 |
| 01/10/2008 | 6.988094 | -8.2 | 0.557143 | 1.64131 | -15.9361 | 58.59594 | 1 |
| 01/01/2009 | 8.39068 | -5.4 | 0.186667 | 1.17845 | -23.0308 | 45 | 1 |
| 01/04/2009 | 9.38566 | -0.5 | 0.176154 | 1.16207 | -26.3718 | 33.01571 | 1 |
| 01/07/2009 | 9.732742 | 1.3 | 0.157857 | 0.99043 | -24.9231 | 25.48625 | 0 |
| 01/10/2009 | 10.08633 | 3.9 | 0.118462 | 1.41598 | -10.981 | 23.07016 | 0 |
| 01/01/2010 | 9.948991 | 1.7 | 0.133846 | 1.55419 | 3.88202 | 20.14967 | 0 |
| 01/04/2010 | 9.832316 | 3.9 | 0.190769 | 1.32866 | 16.2785 | 26.39143 | 0 |
| 01/07/2010 | 9.599191 | 2.7 | 0.189231 | 1.29264 | 21.11312 | 24.28359 | 0 |
| 01/10/2010 | 9.699566 | 2.5 | 0.189231 | 0.97066 | 11.10978 | 19.31844 | 0 |
| 01/01/2011 | 9.15664 | -1.5 | 0.155385 | 1.0544 | 5.61469 | 18.61484 | 0 |
| 01/04/2011 | 9.206172 | 2.9 | 0.095385 | 1.39953 | 4.30175 | 17.48238 | 0 |
| 01/07/2011 | 9.107213 | 0.8 | 0.084615 | 1.661 | 1.29569 | 30.58359 | 0 |
| 01/10/2011 | 8.804835 | 4.6 | 0.075385 | 1.86132 | 9.5838 | 29.93952 | 0 |
| 01/01/2012 | 8.34839 | 2.7 | 0.101538 | 2.08583 | 14.28461 | 18.20403 | 0 |
| 01/04/2012 | 8.267272 | 1.9 | 0.151538 | 1.94555 | 12.7345 | 20.03571 | 0 |
| 01/07/2012 | 8.098936 | 0.5 | 0.145385 | 1.74765 | 12.10444 | 16.1927 | 0 |
| 01/10/2012 | 7.968335 | 0.1 | 0.159231 | 1.77869 | 3.72597 | 16.7529 | 0 |
| 01/01/2013 | 7.790427 | 2.8 | 0.147692 | 1.62823 | 4.6695 | 13.527 | 0 |
| 01/04/2013 | 7.670383 | 0.8 | 0.117692 | 1.44183 | 3.42061 | 14.83703 | 0 |
| 01/07/2013 | 7.398397 | 3.1 | 0.086154 | 1.48061 | 7.04133 | 14.27969 | 0 |
| 01/10/2013 | 7.100853 | 4 | 0.086154 | 1.49103 | 9.33523 | 14.23281 | 0 |
| 01/01/2014 | 6.734929 | -0.9 | 0.072308 | 1.46382 | 4.30437 | 14.82885 | 0 |
| 01/04/2014 | 6.293332 | 4.6 | 0.09 | 1.6664 | 6.85005 | 12.73825 | 0 |
| 01/07/2014 | 6.161251 | 5.2 | 0.09 | 1.71011 | 6.38591 | 13.07266 | 0 |
| 01/10/2014 | 5.81125 | 2 | 0.100714 | 1.54519 | 4.65454 | 16.07234 | 0 |
| 01/01/2015 | 5.618453 | 3.2 | 0.114167 | 1.37439 | 9.53516 | 16.56475 | 0 |
| 01/04/2015 | 5.508363 | 2.7 | 0.123846 | 1.30534 | 5.84106 | 13.74016 | 0 |
| 01/07/2015 | 5.187235 | 1.6 | 0.132857 | 1.29595 | 3.50479 | 19.30734 | 0 |
| 01/10/2015 | 5.142381 | 0.5 | 0.160769 | 1.32889 | 2.1954 | 17.03328 | 0 |
| 01/01/2016 | 5.017911 | 0.6 | 0.359231 | 1.64829 | -1.91331 | 20.48623 | 0 |
| 01/04/2016 | 4.972288 | 2.2 | 0.368462 | 1.72473 | -2.78426 | 15.67594 | 0 |
| 01/07/2016 | 4.951935 | 2.8 | 0.395385 | 1.84218 | -2.67509 | 13.23391 | 0 |
| 01/10/2016 | 4.811847 | 1.8 | 0.441538 | 1.86677 | 0.92133 | 14.09794 | 0 |
Graphical Representation of Selected Variables
TEST APPLIED
Model 2: OLS, using observations 2002:1-2016:4 (T = 60)
Dependent variable: GDP
| Coefficient | Std. Error | t-ratio | p-value | ||
| const | 4.55958 | 2.42246 | 1.882 | 0.0653 | * |
| UR | 0.0522541 | 0.188458 | 0.2773 | 0.7826 | |
| VIXCLS | −0.112134 | 0.0392154 | −2.859 | 0.0061 | *** |
| Recession | −2.24927 | 1.05823 | −2.125 | 0.0382 | ** |
| RRate | 0.0929750 | 0.224720 | 0.4137 | 0.6807 | |
| InflationRate | −0.411041 | 1.06735 | −0.3851 | 0.7017 | |
| PDI | 0.0442853 | 0.0360426 | 1.229 | 0.2246 |
| Mean dependent var | 1.930000 | S.D. dependent var | 2.438345 | |
| Sum squared resid | 172.4819 | S.E. of regression | 1.803989 | |
| R-squared | 0.508299 | Adjusted R-squared | 0.452634 | |
| F(6, 53) | 9.131504 | P-value(F) | 7.34e-07 | |
| Log-likelihood | −116.8147 | Akaike criterion | 247.6295 | |
| Schwarz criterion | 262.2899 | Hannan-Quinn | 253.3640 | |
| rho | 0.096177 | Durbin-Watson | 1.785447 |
Breusch-Pagan test for heteroskedasticity –
Null hypothesis: heteroskedasticity not present
Test statistic: LM = 3.44105
with p-value = P (Chi-square (6) > 3.44105) = 0.751795
LM test for autocorrelation up to order 4 –
Null hypothesis: no autocorrelation
Test statistic: LMF = 0.327625
with p-value = P (F(4, 49) > 0.327625) = 0.858083
FORECAST
For 95% confidence intervals, t (53, 0.025) = 2.006
| Obs | GDP | prediction | std. error | 95% interval |
| 2017:1 | undefined | 2.56340 | 1.89232 | (-1.23211, 6.35890) |
| 2017:2 | undefined | 2.51650 | 1.89776 | (-1.28991, 6.32292) |
INTERPRETATION OF RESULTS
Tests reveal that only Volatility, Price Index and Recession have significant related to GDP growth (real), as the p-value for both variables is less than 0.05 (the confidence interval/significant value). For all other variables, the p-value is greater than 0.05, which is why there is no substantial relationship between GDP and the rest of the variables (excluding Recessions and Volatility Index (CBOE S&P 500).
THE VALIDITY OF THE TEST
To test the validity of the outcome, we have used various tests, which include Durban-Watson (for autocorrelation) test, Breusch-Pagan test (for heteroskedasticity) and LM Test of Order 4 for Auto-Correlation. The value of Durban-Watson test is 1.785447, which indicates that there is no autocorrelation (ideal value would have been around 2). The p-values for, Breusch-Pagan test and LM Test are greater than 0.05, which indicates that there is no heteroskedasticity and correlation respectively.
FORECAST
By using statistical software, GRETL, we were able to forecast values, about GDP, of two missing observations.
CONCLUSION
It is concluded that our retrieved and tested data showed a significant relationship between GDP growth, Recession and Volatility Index. It failed to show any significant relationship between other variables and GDP growth. There is a negative relationship between GDP growth and significant variables, which imply then whenever volatility will increase, GDP growth will dwindle. Similarly, during the recessionary period, GDP growth will slow down.
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