How the Economy Actually Works

A Glass House Guide

Everything you need to understand the news—explained like you're smart, not like you have a finance degree.

---

Why This Guide Exists

You've heard economists on TV throwing around terms like "GDP," "inflation," and "the Fed." They assume you know what they mean. You nod along, but secretly you're thinking: What does any of this have to do with my life?

This guide fixes that.

By the end, you'll understand what economic news actually means—and more importantly, whether you should care.

---

Part 1: The Economy Is Just People Making Decisions

Here's the simplest definition of "the economy" you'll ever hear:

The economy is millions of people deciding what to buy, where to work, and what to make—all at the same time.

That's it. When economists talk about "the economy," they're talking about the combined effect of every purchase, every paycheck, every business decision, and every government policy happening simultaneously.

The Grocery Store Analogy

Think about your local grocery store.

Every day, thousands of people walk in with different needs. One person needs diapers. Another wants steak for a birthday dinner. Someone else is buying ramen because payday isn't until Friday.

The store has to guess what people will want. They order products, set prices, hire workers, and hope they got it right. If they stock too much milk, it spoils. Too little bread, and customers go elsewhere.

Now multiply that by every store, every restaurant, every factory, every office, and every home in the country—all making decisions at the same time, all affecting each other.

That's the economy.

Why It Matters to You

When someone says "the economy is doing well," they usually mean:

• Most people who want jobs can find them
• Businesses are selling enough stuff to stay open
• Prices aren't rising so fast that your paycheck feels worthless

When they say "the economy is struggling," they mean the opposite.

---

Part 2: GDP—The Economy's Report Card

GDP stands for Gross Domestic Product. It's the total value of everything produced in a country over a period of time (usually a year or a quarter).

The Pizza Shop Analogy

Imagine a pizza shop that made 1,000 pizzas last year and sold them for $15 each. Their "GDP" would be $15,000—the total value of what they produced.

Now imagine every business in America—every pizza shop, hospital, car factory, law firm, and lemonade stand. Add up everything they produced and sold. That's America's GDP.

In 2024, U.S. GDP was roughly $28 trillion. That's $28,000,000,000,000. It's a mind-boggling number, but the number itself matters less than whether it's growing or shrinking.

What GDP Growth Means

• GDP growing 2-3% per year: Things are humming along. Jobs are being created. Businesses are expanding. This is the "normal" everyone hopes for.

• GDP growing fast (4%+): The economy is running hot. Lots of jobs, lots of spending—but also risk of prices rising too fast (inflation).

• GDP flat or shrinking: Trouble. Businesses cut back. Layoffs happen. This is called a recession if it lasts long enough.

What GDP Doesn't Tell You

GDP is a big, blunt number. It doesn't tell you:

• Whether regular people are doing better (rich people getting richer also raises GDP)
• Whether jobs pay well
• Whether anyone's actually happy

A country can have great GDP growth while most people feel squeezed. This is why you'll often hear about GDP and other numbers like unemployment and wages.

---

Part 3: Inflation—When Your Dollar Buys Less

Inflation is when prices rise over time. The same $20 bill buys fewer groceries this year than it did last year.

The Allowance Analogy

Imagine you get $10 a week in allowance. Last year, that bought you 10 candy bars at $1 each. This year, candy bars cost $1.25. Now your $10 only buys 8 candy bars.

Your allowance didn't shrink—but what it can buy did. That's inflation.

Why Prices Rise

Prices go up for two main reasons:

1. More money chasing the same stuff (demand-pull inflation)

If everyone suddenly has more money—say, from government stimulus checks—they spend more. But stores don't magically have more products. When more people want to buy the same amount of stuff, sellers raise prices because they can.

2. Stuff costs more to make (cost-push inflation)

If oil prices spike, it costs more to ship products. If there's a shortage of computer chips, car prices rise. If wages go up, restaurants charge more for meals. These costs get passed to you.

How Inflation Is Measured

The government tracks prices of hundreds of common items—groceries, gas, rent, clothes, movie tickets. They bundle these into the Consumer Price Index (CPI).

When you hear "inflation was 3.2% this year," it means the average price of that bundle rose 3.2% compared to last year.

Is Inflation Good or Bad?

A little inflation (2-3%) is actually normal and healthy. It means the economy is growing. The Federal Reserve actually targets 2% inflation as the sweet spot.

Too much inflation (5%+) is a problem. Your paycheck doesn't go as far. Savings lose value. People feel poorer even if they're technically earning the same amount.

No inflation or deflation (falling prices) is also bad. Wait, why? If prices are falling, people wait to buy things ("that TV will be cheaper next month"). Businesses sell less. They lay off workers. Those workers spend less. It becomes a downward spiral.

What This Means for You

Inflation Level

What It Feels Like

0-2%	Prices feel stable. Normal life.
2-3%	Slight increases, barely noticeable month-to-month
3-5%	You notice groceries and gas cost more
5-7%	Your paycheck feels tighter. You make trade-offs.
7%+	Real pain. You cut spending or dip into savings.

---

Part 4: The Federal Reserve—The Economy's Thermostat

The Federal Reserve (usually just called "the Fed") is America's central bank. Their main job is to keep the economy from getting too hot or too cold.

The Thermostat Analogy

Think of the economy like a house, and the Fed controls the thermostat.

• Economy too hot (too much inflation, prices rising fast): The Fed "turns down the heat" by raising interest rates. This slows borrowing, slows spending, and cools things off.

• Economy too cold (recession, people losing jobs): The Fed "turns up the heat" by lowering interest rates. This makes borrowing cheaper, encourages spending, and warms things up.

The Fed can't control the economy perfectly—just like your thermostat can't make every room the exact same temperature. But they try to keep things in a comfortable range.

What Are Interest Rates?

An interest rate is the price of borrowing money.

When you get a car loan, credit card, or mortgage, you pay interest—a percentage on top of what you borrowed. That percentage is the interest rate.

When the Fed "raises rates" or "cuts rates," they're changing a specific rate called the federal funds rate. This is the rate banks charge each other for overnight loans. It sounds obscure, but it ripples through the entire economy:

• Fed raises rates → Banks raise their rates → Your mortgage, car loan, and credit card rates go up → Borrowing becomes expensive → People spend less → Economy cools down

• Fed cuts rates → Banks lower their rates → Borrowing becomes cheaper → People buy houses, cars, and stuff → Economy heats up

Why the Fed Matters to You

Fed Action

Effect on You

Fed raises rates	Mortgage rates rise. Credit cards cost more. Savings accounts pay more. Home prices may cool.
Fed holds rates	Things stay roughly the same.
Fed cuts rates	Mortgages get cheaper. Good time to refinance. Savings accounts pay less. Stocks often rise.

The Fed's Impossible Job

The Fed is always walking a tightrope:

• Raise rates too much → Economy crashes into recession, people lose jobs
• Raise rates too little → Inflation runs wild, money loses value
• Lower rates too much → Bubbles form (like housing in 2008)
• Lower rates too little → Recovery is too slow

This is why you hear so much about what the Fed "might do." Their decisions affect mortgage rates, job markets, and stock prices—which means they affect your life.

---

Part 5: Unemployment—The Job Market Thermometer

The unemployment rate tells you what percentage of people who want jobs can't find them.

The Basics

• Employed: You have a job
• Unemployed: You don't have a job, but you're actively looking for one
• Not in the labor force: You're not working AND not looking (retirees, students, stay-at-home parents, people who've given up)

The unemployment rate = (Unemployed people) ÷ (Employed + Unemployed people) × 100

What the Numbers Mean

Unemployment Rate

What It Means

3-4%	Very tight job market. Employers compete for workers. Wages tend to rise. Hard to get fired; easy to find a new job.
4-5%	Healthy range. Jobs available, but not desperate.
5-6%	Softening market. Finding a job takes longer. Employers have more leverage.
6-8%	Weak job market. Layoffs happening. Workers have less bargaining power.
8%+	Serious trouble. Recession territory. Many people struggling.

For reference, unemployment hit 14.7% in April 2020 (COVID peak) and was around 3.5% in early 2024 (historically low).

What Unemployment Doesn't Capture

The official number misses some important things:

• Underemployment: You have a job, but it's part-time when you want full-time, or you're way overqualified
• Discouraged workers: People who gave up looking (they're not counted as "unemployed")
• Gig economy gray areas: Uber drivers and freelancers who technically "have work" but not stable employment

This is why economists also look at other measures like the "U-6 rate," which includes underemployment. It's usually 2-3 percentage points higher than the official rate.

---

Part 6: The Stock Market—Not the Same as the Economy

The stock market is where people buy and sell ownership in companies. When you hear "the Dow rose 300 points" or "the S&P 500 fell 2%," that's the stock market.

The Important Distinction

The stock market is NOT the economy.

The stock market reflects what investors think will happen to large company profits. The economy is what's actually happening to regular people—jobs, wages, prices.

They're related, but not the same:

• Stock market can boom while workers struggle (investors love layoffs—it means higher profits)
• Economy can be fine while stocks tumble (investors might panic about something that never happens)

What the Numbers Mean

You'll hear about three main stock indexes:

Dow Jones Industrial Average (the Dow): 30 giant companies. Old-school measure. Not very representative anymore, but still gets quoted constantly.

S&P 500: 500 large U.S. companies. Better measure of the overall stock market. This is what most people mean when they say "the market."

NASDAQ: Heavily weighted toward tech companies. Goes up more when tech is hot, crashes harder when tech struggles.

Should You Care About Daily Moves?

If you're investing for retirement (20+ years away): No. Daily moves are noise. The market goes up over decades, even though it bounces around daily.

If you're retiring soon or already retired: A little more. You might want less in stocks because you can't wait out a crash.

If you're not invested at all: The stock market doesn't directly affect you day-to-day. But it does affect the mood—when stocks crash, companies often get cautious about hiring.

What Moves the Stock Market

• Company earnings: Did Apple make more profit than expected? Stock goes up.
• Interest rates: When the Fed raises rates, stocks often fall (borrowing costs more, and bonds become more attractive).
• Economic data: Strong jobs report? Stocks might rise (economy is healthy) or fall (Fed might raise rates).
• Vibes: Seriously. Investor sentiment, fear, greed, and headlines all move markets.

---

Part 7: Bonds and Interest Rates—The Boring Stuff That Matters

A bond is a loan you give to a company or government. They pay you back later, with interest.

The IOU Analogy

Imagine you lend your friend $100. They promise to pay you back $105 next year. That $5 is the interest—your reward for waiting and for taking the risk they might not pay you back.

Bonds work the same way, just bigger:

• Treasury bonds: Loans to the U.S. government. Very safe, lower interest.
• Corporate bonds: Loans to companies. Riskier, higher interest.
• Municipal bonds: Loans to cities and states. Often tax-free.

Why Bond Yields Matter

The yield is the effective interest rate a bond pays. When news says "the 10-year Treasury yield hit 4.5%," it means if you lend the government money for 10 years, they'll pay you 4.5% per year.

Here's the weird but important part: When bond prices go up, yields go down. And vice versa.

Don't worry about the math. Just know that when investors get scared, they buy bonds (safe haven), which pushes yields down. When they're confident, they sell bonds for stocks, which pushes yields up.

Why You Should Care About the 10-Year Treasury

The 10-year Treasury yield is the benchmark for long-term borrowing costs in America:

• Mortgage rates roughly track the 10-year Treasury plus a markup
• Corporate borrowing costs are based on Treasury rates plus their risk premium
• Student loan rates (for federal loans) are tied to Treasury auctions

So when the 10-year yield rises, your mortgage rate rises too—even if the Fed hasn't done anything.

10-Year Treasury Yield

Approximate Mortgage Rate

What It Means

3.0%	~5.5-6.0%	Low rates, good time to buy/refinance
4.0%	~6.5-7.0%	Average range
5.0%	~7.5-8.0%	High rates, expensive to borrow

---

Part 8: Recessions—When Everything Contracts

A recession is when the economy shrinks for an extended period. The technical definition is two consecutive quarters of negative GDP growth, but the official call is made by economists at the National Bureau of Economic Research (NBER).

What Happens in a Recession

1. Businesses sell less (people cut spending)
2. Businesses cut costs (layoffs, hiring freezes)
3. Unemployed people spend even less
4. More businesses struggle
5. Cycle continues

It's a negative spiral that feeds on itself until something breaks the cycle (usually government spending or Fed rate cuts).

Recent Recessions

Recession

Duration

Peak Unemployment

What Caused It

2020 (COVID)	2 months	14.7%	Pandemic shutdowns
2008-2009 (Great Recession)	18 months	10%	Housing bubble, bank failures
2001 (Dot-com)	8 months	6.3%	Tech bubble burst, 9/11

Signs a Recession Might Be Coming

Economists watch for warning signs:

• Inverted yield curve: When short-term bonds pay more than long-term bonds, it's historically predicted recessions
• Rising unemployment claims: More people filing for unemployment
• Falling consumer spending: People buy less stuff
• Business confidence dropping: Companies stop investing

But here's the thing: Recession predictions are often wrong. People have been predicting a recession since 2022, and it hasn't happened (as of early 2026). The economy is hard to forecast.

What to Do If You're Worried About a Recession

• Have an emergency fund: 3-6 months of expenses in savings
• Don't panic-sell investments: Markets recover. Selling locks in losses.
• Be thoughtful about big purchases: Maybe wait on the new car if your job seems shaky
• Stay employable: Keep your skills current

---

Part 9: Deficits and the National Debt—Money the Government Owes

The federal deficit is how much more the government spends than it collects in taxes each year. The national debt is the total amount the government owes—all the deficits added up over time.

The Household Analogy (With Caveats)

Imagine your family earns $60,000 a year but spends $75,000. You cover the $15,000 gap with a credit card. That $15,000 is your deficit. After 10 years of doing this, you owe $150,000 (plus interest). That's your debt.

The U.S. government does something similar:

• Revenue (income): Taxes—about $5 trillion/year
• Spending: Programs, military, interest—about $6.5 trillion/year
• Deficit: The gap—about $1.5 trillion/year added to the debt
• Total debt: About $34 trillion and growing

Why It's More Complicated Than a Household

Governments aren't households. Key differences:

1. The government prints the money. It can't technically "run out" of dollars (though printing too much causes inflation).

1. The government lives forever. You have to pay off your debts before you die. The government can roll over debt indefinitely.

1. The U.S. borrows in its own currency. Some countries borrow in dollars or euros and can genuinely go broke. The U.S. borrows in dollars—which it creates.

1. Investors keep lending to the U.S. Treasury bonds are considered the safest investment in the world. As long as people want them, the U.S. can borrow.

Should You Worry About the National Debt?

Honest answer: Economists disagree.

Team "It's Fine (For Now)":

• Interest rates are manageable
• The dollar is the world's reserve currency
• Debt-to-GDP has been higher in other countries without collapse
• Cutting spending during downturns makes recessions worse

Team "It's a Problem":

• Interest payments are rising fast (now over $1 trillion/year)
• At some point, investors might demand higher rates
• We're borrowing for consumption, not investment
• Future generations inherit the bill

The practical reality: The debt isn't causing immediate problems, but the trend isn't sustainable forever. It will eventually require either higher taxes, less spending, or higher inflation—probably some combination.

---

Part 10: Trade—Why Countries Buy From Each Other

Trade is when countries buy and sell goods and services to each other. The U.S. exports (sells to other countries) and imports (buys from other countries).

Why Countries Trade

No country can make everything well. The U.S. is great at software, movies, and airplanes. China is great at electronics manufacturing. Saudi Arabia has oil. Brazil grows coffee.

Trade lets countries specialize in what they're good at and buy the rest. Everyone (theoretically) ends up with more stuff at lower prices.

Trade Balance and Trade Deficits

• Trade surplus: You export more than you import (you sell more than you buy)
• Trade deficit: You import more than you export (you buy more than you sell)

The U.S. runs a trade deficit—we buy more from the world than we sell. In 2024, that deficit was about $800 billion.

Is a trade deficit bad?

Not necessarily. It means Americans are buying lots of stuff (strong consumer demand) and that the U.S. dollar is valuable (other countries want our money). But large, persistent deficits can mean domestic industries struggle to compete.

Tariffs and Trade Wars

A tariff is a tax on imported goods. If the U.S. puts a 25% tariff on Chinese steel, importers pay 25% extra, which makes Chinese steel more expensive.

Why governments use tariffs:

• Protect domestic industries from foreign competition
• Punish countries for unfair practices
• Generate revenue (though this is a smaller reason today)

The downside:

• Higher prices for consumers (you pay more for stuff)
• Other countries retaliate with their own tariffs
• Trade wars can hurt everyone

What This Means for You

Trade Policy

Effect on You

Free trade (low tariffs)	Cheaper imported goods. Some domestic jobs lost to competition.
Protectionism (high tariffs)	More expensive imported goods. Some domestic jobs protected.
Trade war	Higher prices on many goods. Economic uncertainty.

---

Part 11: How It All Connects

Here's where it comes together. Economic forces don't operate in isolation—they affect each other.

The Chain Reactions

Example 1: The Fed raises interest rates → Mortgage rates rise → Fewer people buy houses → Home prices cool off → Construction slows → Construction workers get laid off → Those workers spend less → Restaurants and stores see less business → They slow hiring too

Example 2: Oil prices spike → Gas costs more → Shipping costs more → Everything that gets shipped costs more (i.e., everything) → Inflation rises → The Fed raises rates to fight inflation → (See Example 1)

Example 3: Big tech companies do layoffs → Stock prices might actually rise (lower costs = higher profits) → But affected workers spend less → Local businesses in tech hubs struggle → Those workers file for unemployment → Unemployment rate ticks up → Fed might pause rate hikes

The Dashboard View

Here's a quick reference for how to read the economic news:

If You See This...

It Usually Means...

GDP growing 2-3%	Economy is healthy
GDP shrinking	Recession risk
Inflation above 4%	Your money buys less
Fed raising rates	Borrowing getting expensive
Fed cutting rates	Borrowing getting cheaper
Unemployment below 4%	Easy to find jobs
Unemployment above 6%	Hard to find jobs
10-year yield rising	Mortgage rates rising
Stock market up	Investor optimism (not necessarily worker wellbeing)
Stock market down	Investor fear (not necessarily a recession)

---

Part 12: What to Actually Do With This Information

Knowing how the economy works is useful. But what do you actually do differently?

For Your Career

• Low unemployment: Good time to ask for a raise or look for a better job. Employers are competing for workers.
• Rising unemployment: Focus on job security. Build skills. Have a backup plan.
• Recession fears: Don't panic, but avoid unnecessary risks like quitting without another job lined up.

For Big Purchases

• Fed cutting rates: Good time to buy a house or refinance (rates will drop).
• Fed raising rates: Maybe wait on the house if you can. Rates are high.
• High inflation: Buying now might actually make sense—that car will cost more next year.

For Investing

• Younger (20+ years to retirement): Ignore short-term market swings. Keep investing consistently.
• Closer to retirement: Pay more attention to risk. Maybe less in stocks, more in bonds.
• During a market crash: Don't panic-sell. Historically, staying invested beats trying to time the market.

For Everyday Life

• Have an emergency fund: 3-6 months of expenses. This is your buffer against whatever the economy throws at you.
• Don't overspend in good times: When money is flowing, save some. The economy is cyclical.
• Stay informed, not obsessed: Read the headlines, understand the trends, but don't check your 401(k) daily.

---

Glossary: Quick Reference

Term	Plain English

GDP	Total value of everything the country produces
Inflation	Prices rising (your dollar buys less)
Deflation	Prices falling (usually bad—people stop buying)
The Fed	Central bank that controls interest rates
Interest rate	The price of borrowing money
Unemployment rate	% of people who want jobs but can't find them
Recession	Economy shrinking, jobs disappearing
Bull market	Stocks going up
Bear market	Stocks going down 20%+ from recent high
Bond	A loan to a company or government that pays interest
Yield	The interest rate a bond pays
Treasury	A bond issued by the U.S. government
Deficit	Government spends more than it collects (this year)
National debt	Total amount government owes (all years combined)
Tariff	Tax on imported goods
Trade deficit	Country buys more from abroad than it sells

---

One Last Thing

The economy isn't mysterious. It's just lots of people making decisions, and the patterns that emerge from those decisions.

You don't need a finance degree to understand it. You just need clear explanations and a willingness to pay attention.

That's what Glass House Economy is for.

---

Glass House Guide: How the Economy Actually Works See Through the Markets