Nominal GDP is not real (and is really tiny)
By Scott Sumner
Sometimes I argue that nominal GDP is like Coke, it’s the “real thing.” By that I mean it’s a well-defined concept, the dollar value of all output of final goods and services. Of course I exaggerate, there are some conceptual problems in how to define NGDP. But real GDP has all those problems, and much deeper ones.
Some government statistics define real GDP as “volume” of output. But that’s nonsense; it would put a country in the midst of heavy industrialization (like China) far ahead of a high tech society like ours. The next defense of real GDP is the price index, but how is that to be measured? The change in the price of a given basket of goods? But which basket, and how to we address new goods, and changes in quality? There are no good answers to these questions, which is why no one agrees as to whether US living standards have stagnated since 1970, or risen rapidly (as I claim.) On the other hand, we all pretty much agree as to what has happened to NGDP since 1970.
But there is another sense where real GDP really is very much real, and NGDP isn’t. RGDP is something that can be pictured in one’s mind—“the economy.” You can picture all those factories churning out cars, all those homes housing people, all those barbers cutting hair. But NGDP can’t really be pictured. Don’t believe me? Try to picture the explosive growth in Zimbabwe’s NGDP during the early 2000s in your mind’s eye. My claim is that either you cannot, or you end up picturing bushels of worthless currency. And that’s because NGDP is essentially a monetary concept, not real.
By analogy, if Switzerland had used gold as its money, its NGDP would have plunged much lower since the early 2000s, although it would have rebounded somewhat in the last couple years. But that fact would tell us nothing about the Swiss economy we picture in our mind’s eye. It tells us about the international market for gold, where prices soared in relative terms, then fell back somewhat.
In a recent comment section there was skepticism about my claim that a couple of small interest rate increases in 2011 could have plunged the eurozone into another recession, associated with a sharp slowdown in NGDP growth. There are two problems with that criticism:
1. I don’t actually believe the higher interest rates were the best way of describing the problem. I prefer “tight money” and just threw out the interest rate increases as a “concrete step” for what Nick Rowe calls the “people of the concrete steppes.” Interest rates are not a good indicator of the stance of monetary policy, and eurozone money was much tighter than the increase from 1% to 1.5% would have suggested.
2. The other problem with the skepticism is the implicit assumption that NGDP is some vast thing, and that a central bank would have trouble nudging it this way or that. No, real GDP is a vast thing, and as I said can be pictured in one’s mind’s eye. NGDP is a tiny thing, no larger than a dollar bill. Suppose the Fed depreciates the one-dollar bills that it has a monopoly on producing, from 1/17,000,000,000,000th of a year’s output, to 1/18,000,000,000,000th of a year’s output. Then they’ve just boosted NGDP from $17 trillion to $18 trillion.
I think the problem is that people think of the central bank as being like a tugboat, slightly nudging a huge ocean liner this way and that. This sort of analogy would be sort of OK (although not perfect) for central banks trying to influence real GDP. They can do so in the short run, to some extent. But when we shift over to NGDP the analogy completely breaks down. Now the central bank is no longer the tugboat trying to nudge the ocean liner, it is the ocean liner itself. It steers the nominal economy.
The path of NGDP is monetary policy. Through errors of omission or commission, the ECB has created the path of NGDP that we observe since 2007.
Do those shifts in NGDP also cause the truly vast real GDP to move around? Most conventional Keynesians and monetarists (and Austrians?) would say yes, but only in the short run. This is usually attributed to sticky wages and prices (or perhaps misperceptions.)