Thursday, August 16, 2012

Nominal and Real GDP: A Barrier to a Statistical Approach

Scott Sumner regularly talks about how almost all discussions of inflation become much clearer in terms of NGDP. This is because people have a hard time differentiating between inflation as a result of more aggregate demand (demand-push) and inflation as a result of less aggregate supply (cost-pull). The difference is summarized in the textbook aggregate demand/aggregate supply diagrams below:

Aggregate demand expansion = Inflation

Demand pull inflation - increased aggregate demand


Aggregate supply contraction = inflation

Cost push inflation




The first kind of inflation changes NGDP, while the second has minimal impact. This way, when we are in a recession and demand more inflation, what we really mean is that we need more of the first kind of inflation because we need more NGDP. If we were in the second situation, we wouldn't be demanding more or less NGDP because the supply shock would have had minimal impact.

Another example in which NGDP makes explanations easier is in discussions of whether deflation is bad in an economy. Often times, liberal economists will point to the recent recession and say deflation is bad, while libertarians might point to the late 19th century, early 20th century and say that deflation is good. The more correct answer is that stable NGDP is best. So because the first kind of deflation reduced NGDP, it was bad, while the second type of deflation kept NGDP steady, and therefore was good.

While NGDP is simple, it makes it hard to statistically show NGDP boosts RGDP. You can't look at a graph and point to any correlation; a skeptic could just say that it's the RGDP that's driving the movements in NGDP, and not the other way around. In the end, to explain the relationship between nominal and real output in AD shocks, I have to find specific channels, such as nominal debt. On the other hand, inflation and output make much more sense in terms of trying to find statistical relationships. These concepts are far enough in people's minds that a relationship doesn't seem like a tautology. However, when you start directly talking about NGDP and RGDP, it's too easy for people to think the observed relationship between NGDP and RGDP is just because the second is a component of the first.

4 comments:

  1. Targeting nominal-gDp just CAPs the standard-of-living for the average American.

    Try selling it to the Chinese where current price real-gDp averaged 15.74% per each qtr for the last 20 years (rose 39.4% 1st qtr 1994).

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  3. 1. Anyone that examined the R-O-C (rate-of-change) in nominal gDp during 2007, 2008, & 2009 would see that the FED failed to act. It failed to increase both the stock of money & its rate-of-turnover in response to the decline in economic activity (nominal-gDp).

    However the FED’s research staff calculated otherwise: “These broader series grew more steadily both before & during the crisis. Although the evidence is mixed, the MSI overall suggest that monetary policy was accommodative before the financial crisis when judged in terms of liquidity. —Richard G. Anderson & Barry Jones (STL-FRB)

    The Fed conducted two separate contractionary monetary policies prior to the Great Recession. Monetary flows (MVt or our means-of-payment money X’s its transactions rate-of-turnover) fell (at roc’s less than zero) for 29 consecutive months beginning Feb 2006. Then during the crash in the 4th qtr of 2008 the Fed tightened at the same time economic activity was collapsing.

    Accelerated real-growth is based upon a switch from a tight money policy to an expansive money policy involving open market purchases of securities from the non-bank public for c. 3 quarters. Then the easy money policy would be stopped & a tighter money policy would be substituted for c. 5 quarters (the level depending upon the desired rate-of-change in gDp’s components).

    This would compress the initial price increases taking place when trying to boost real-gDp in the first 3 qtrs (re-growth). By the end of the next 5 quarters the actual price level would end up conforming to the long-term trend roc in monetary flows (MVt). That’s the correct periodicity (time-line). It provides the biggest boost to real-gDp, while at the same time raising nominal-gDp (ultimately keeping inflation at bay).

    I.e., inflation is measured from the beginning of its reference point to its ending reference point (fixed monetary lag). So gyrations between those points (acceleration in inflation), from a macro-economic standpoint, are “washed out” over the longer term (because inflation's &/or real output's equations are based on starting & ending points (regardless of the fluctuations in between). It is the (roc) between those reference points relative to the output of goods & services that's determines nominal-gDp.

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