ePAROL - Economic News and Views

Using the GDP to measure inflation

From "The Mogambo" Sept 20, 2006

"Raw GDP is the way the US measures GDP, which is the total of money made from final sales. Some of that is, of course, the result of higher prices."

"The reason that this is so important to figure in is that, by example, if last year the raw GDP number came from selling one widget for a buck (a $1 GDP), and this year raw GDP was one widget sold for two bucks (a $2 GDP), the economy looks like it doubled! GDP went from $1 to $2!" Everyone then says how wonderful the economy is doing.

But in reality, it did not actually grow; only one widget was made and sold still! The only thing that changed was the price of the widget. That is a result of inflation itself.

So if you want to know how the REAL economy is going in the exciting world of GDP and widget-making, you have to reduce the raw GDP figure by the rate of inflation.

Uh-oh!! Those of you familiar with the Mogambo Theory Of Soundtracks (MTOS) recognize the sense of foreboding doom as, suddenly, the soundtrack is filled with low, rumbling horns making screechy, horrible, dis-chords, and the penetrating sound of doomed souls wailing in economic and financial despair. Obviously, this is where it gets very interesting!

See, if the rate of inflation that you use to deflate the raw GDP number is too low (like it is now!), then the estimate of real, inflation-adjusted GDP is too high! The economy looks like it is going great, but it is, obviously, not. It's just that prices are rising!

So, if GDP is predicted to grow only 2.9%, with the assumption that inflation is only 3%, then the error is huuuUUUuuge when you use the 3% inflation to go back to get the raw GDP number, and then deflate by the actual rate of inflation (probably somewhere between 4.1% and 10%).

When you do that, you get a result that is so horrible, so terrifying to see that, like looking at a Gorgon, my brain is literally turning to stone, and all I can do is claw at my own head and cry out in anguish, "Not only are we in recession, as real GDP growth is actually negative, but we have been in one for years and years! Gaaahhh!"

To repeat: We are, and have been, in a recession, according to the new inflation number!

posted by G @ 9:50 AM