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... even if it can only ever be an approximate correction:
This also ties GDP closely to 'growth', because a lot of apparent growth will come from increased prices - and this has a worrying circularity about it, as a notion.

GDP deflator = [Actual GDP/"Real" GDP]x100

so:

GDP deflator inflation rate approximately equals
 % growth in Actual GDP minus % growth in "Real" GDP.

I put the "Real" in ironic quotes, because the number is constructed by supposing that prices had not changed but that the precise same quantities of goods had been sold anyway.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Oct 10th, 2007 at 06:46:40 PM EST
[ Parent ]
Well, that's a nice way to fudge it. :)

I still think it's circular because it's not making a qualitative distinction between different kinds of prices.

The simplest social definition of inflation is that it decreases the choices available to participants in the economy.

This means not all prices are equal. If food becomes 50% more expensive, I have little or no choice but to buy it. (Assuming I'm on a standard and not on a luxury diet.) That means my choices decrease - I have less money to spend on non-essentials, and I have no flexibility in this.

If luxury yachts become 50% more expensive, no one's choices are seriously diminished. Yacht wannabes may feel the inflationary sting of not being able to afford the model they want, but yacht buying remains a discretionary activity. And if a yacht becomes unaffordable, it's always possible to spend an equivalent amount on something equally weighed down with bling.

So even though increased yacht prices may count towards inflation using the GDP definition, the price increase is voluntary, the decision to buy is voluntary, and the profit will most likely be recycled into the economy.

But with food prices, the price increase may not be voluntary (because it may be going on overheads), the decision to buy isn't voluntary (or is at least tightly constrained) and the money effectively disappears. (I suppose technically some of it could be recycled as profit, but that's not how it seems to work out.)

So - some prices affect freedom of choice much more than others. And price inflation in some parts of the economy is much more damaging than in other parts. A proper analysis would pick out price elasticity and capital mobility as elements too. (E.g. capital tied up in house prices is, at least partly, lost to the economy, and therefore house price rises are highly inflationary - even thought they're not counted as such today.)

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu Oct 11th, 2007 at 05:18:25 AM EST
[ Parent ]
I still think it's circular because it's not making a qualitative distinction between different kinds of prices.

The simplest social definition of inflation is that it decreases the choices available to participants in the economy.

This means not all prices are equal. If food becomes 50% more expensive, I have little or no choice but to buy it. (Assuming I'm on a standard and not on a luxury diet.) That means my choices decrease - I have less money to spend on non-essentials, and I have no flexibility in this.

I guess economists would wiggle out of this one by pointing out that, unless price rises happen in non-substitutable staples, people can always switch to other foodstuffs.

If there are Giffen Goods in the economy, of course, that is not the case.

But I think however you construct it (even if you do it in what you'd call a "socially sensible way") the GDP Deflator and the Real GDP are not directly measurable, but have to be constructed from the details of the Nominal GDP, which is measurable (at least in principle).

I guess this is another case of an economist going and saying "look here: nominal GDP growth consists of two components: real GDP growth and inflation", and people going "ooh, ahh", and after giving the economist his Nobel price going "but how do you calculate real GDP and inflation?". And after much debating turning to the statisticians and saying "guys, here's the data on all the goods and services traded over time, with amounts and prices". Please figure out a way to calculate the Real GDP and the GDP Deflator.

By the way, there's the following juicy quotation from Keynes:

That the units, in terms of which economists commonly work, are unsatisfactory can be illustrated by the concepts of the national dividend, the stock of real capital and the general price-level:

...

Thirdly, the well-known, but unavoidable, element of vagueness which admittedly attends the concept of the general price-level makes this term very unsatisfactory for the purposes of causal analysis, which ought to be exact.

Nevertheless these difficulties are rightly regarded as 'conundrums'. They are 'purely theoretical' in the sense that they never perplex, or indeed enter in any way into, business decisions and have no relevance to the causal sequence of economic events, which are clear-cut and determinate in spite of the quantitative indeterminacy of these concepts. It is natural, therefore, to conclude that they not only lack precision but are unnecessary. Obviously our quantitative analysis must be expressed without using any quantitatively vague expressions. And, indeed, as soon as one makes the attempt, it becomes clear, as I hope to show, that one can get on much better without them.

The fact that two incommensurable collections of miscellaneous objects cannot in themselves provide the material for quantitative analysis need not, of course, prevent us from making approximate statistical comparisons, depending on some broad element of judgement rather than of strict calculation, which may possess significance and validity within certain limits.

But the proper place for such things as net real output and the general level of prices lies within the field of historical and statistical description, and their purpose should be to satisfy historical or social curiosity, a purpose for which perfect precision—such as our causal analysis requires, whether or not our knowledge of the actual values of the relevant quantities is complete or exact—is neither usual nor necessary. To say that net output to-day is greater, but the price-level lower, than ten years ago or one year ago, is a proposition of a similar character to the statement that Queen Victoria was a better Queen but not a happier woman than Queen Elizabeth—a proposition not without meaning and not without interest, but unsuitable material for the differential calculus. Our precision will be a mock precision if we try to use such partly vague and non-quantitative concepts as the basis of our quantitative analysis.

— John M. Keynes in The General Theory of Employment, Interest and Money



We have met the enemy, and it is us — Pogo
by Migeru (migeru at eurotrib dot com) on Thu Oct 11th, 2007 at 05:43:20 AM EST
[ Parent ]
I guess economists would wiggle out of this one by pointing out that, unless price rises happen in non-substitutable staples, people can always switch to other foodstuffs.

They could, but they'd also admit that the switch was being forced and not a matter of choice. Whereas if prices dropped while wages rose, buyers would have increased choice.

I think if you use choice as the bottom-line criterion a lot of the conceptual confusion disappears.

The problem becomes quantifying that choice. And it's possible a simple one-line model may not be the  best way to do that - and also that choice will vary for different groups, and optimising choice for one demographic may lower the choice of another.

As usual it's a political problem, not an econometric one. You can't create good metrics until you decide what you're trying to achieve socially and politically.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Thu Oct 11th, 2007 at 07:42:29 AM EST
[ Parent ]
... definition are the various CPI's and PPI's (depending on the group of participants you want to focus on).

For the definition of inflation as a sustained, ongoing increase in the average price level in the economy, where the "social definition" above is understood as one possible but not necessary consequence, then some form of GDP deflator is the only practicable approach to encompass that.

And, of course, the "social definition" does not in fact encompass every important scenario involving price inflation, as when there is rapid economic growth accompanied by mild inflation, where the inflation may be redistributing some of the gains but is not imposing substantial losses, and the main concern for those wishing to push the the rate of inflation down is that the redistribution is going from people holding wealth denominated in monetary terms to people holding wealth in real productive capacity and most workers.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Thu Oct 11th, 2007 at 02:15:34 PM EST
[ Parent ]

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