Welcome To The Desert Of Real GDP

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Something worth flagging for the NGDP conversation is that because both real GDP and inflation are familiar subjects of discourse, it seems natural to many people to take them as “given” and understanding NGDP (= GDP + inflation) as somehow constructed and exotic. But actually NGDP is, relatively speaking, the simple quantity here. It measures total spending in the economy. You count everything, add it all up, and you’ve got your NGDP. It’s actually just like the GDP you may have learned about in your intro textbook: Household consumption plus exports plus government purchases plus investment minus imports. Social construction enters the picture when we try to move from this nominal quantity to the allegedly “real” one.

That’s why we have all these different measures of inflation. The Bureau of Economic Analysis produces a GDP Deflator, which is different from the Consumer Price Index which is different from the Personal Consumption Expenditures deflator that the Fed uses. And actually CPI comes in a couple of different flavors, and there are “core” and “non core” versions of many of these things.

Some of this is for very good reason. We want and need for many purposes to try to capture the idea that “the cost of living” may go up so we calculate these different kind of price indexes. And as long as we have some relatively specific purpose in mind, this is great. But it really does matter which index you use and what you’re talking about. Most people’s “cost of living” is dominated by changes in food and energy prices, and changes in local rental markets don’t matter at all. But of course rent matters a lot to the cost of living of renters! And for macroeconomic purposes, changes in gasoline prices aren’t supposed to be an important consideration. That leaves you with a “core” inflation measure which is dominated by rent. You’ve constructed a price index that measures something that has nothing to do with the cost of living facing families. There are very good reasons to think that using this index rather than a cost of living index will lead to better monetary policy. But its a highly artificial index that’s not directly measurable the way NGDP and also doesn’t have anything to do with the intuitive idea of measuring the cost of living.

Nor is it particularly clear what, in principle, “real” GDP is measuring. Think up all the classic critiques of GDP as a measure of human welfare. As long as we’re talking about nominal GDP, you can quite sensibly counter “you’re totally right, this is a lousy measure of human welfare but for many purposes we need to measure the total quantity of spending in our economy.” When you shift from GDP to “real” GDP, though, you’re not measuring the total quantity of spending anymore. You’re controlling for shifts in the price level. To do that you have to try to account for changes in the quality of goods and services that are being sold. At this point, however, you actually are purporting to construct a measure of human welfare. Did the price of cars go up, or did the cars get better? Well better for what?