Gross domestic product (GDP) is a major economic indicator that represents business activity and supports a country's level of productivity. The results for economic activity each quarter reveal the health of an economy over the last three-month period. Economists rely on the data to determine the pace of expansion or contraction while the results also influence the way that monetary policymakers respond when measuring the state of the economy and inflation. Many investors also know the importance of GDP and weigh asset allocation decisions in light of the results.
The importance of GDP becomes apparent upon considering the other major economic barometers that heavily influence the pace of growth or contraction in a country. Jobs are one one such factor and when unemployment is notably high, this is likely to be evident through a shrinking GDP. Although dismal employment statistics do not necessarily translate into an economic recession, which would be signaled through two periods of declines for GDP, it certainly could be a harbinger for things to come. Economists tend to remain cautious on their outlook for the economy as long as unemployment figures are alarmingly high. The importance of GDP is reflected in the fact that economists associate the economic health in a country as indicated by gross domestic product with the conditions for jobs in that nation.
A country's GDP is also viewed in light of the corporate profits being produced in a country. When GDP is slow, investors are likely to be wary of placing capital into the financial markets. Conversely, in an environment where gross domestic product is increasing and profits are growing, the investment conditions appear more promising. It is not unusual for investors to use GDP and corporate profits as gauges for where economic growth is taking place and to direct investment capital into that country. This illustrates the importance of GDP because it shows how investment capital can flow in or out of a nation based on the performance of this indicator.
Government officials who establish short-term interest rates in a country have used the information relayed through GDP to assess the economy's health. If the economy appears to be growing too fast and GDP has shown a pattern of steadily rising, policymakers might evaluate whether a change needs to be made to interest rates in order to keep inflation under control. Changes in interest rates affect the borrowing costs for large institutions and impact consumers, as well. Subsequently, the importance of GDP is recognized because it is a component that top economic officials use to alter financing costs.