Yesterday we came across a Reuters report on the rather pedestrian, to put it mildly, third quarter GDP report. Reported ‘real’ GDP was greatly helped by the GDP deflator once again declining sharply, coming in a full percentage point lower than in the second quarter (1.2% instead of 2.2%). Perceptive readers have probably noticed this pattern already: weak GDP numbers always tend to coincide with outsized declines in the deflator.
A basic problem in this context is that ‘price inflation’ in terms of a general price level cannot possible be measured; or let us rather say, such a measurement simply makes no sense, neither mathematically nor logically.
The main problem is that there is no fixed yardstick which can be used for measurement, as the value of money depends on supply and demand just as other goods do. In other words, one continually changing magnitude is measured with the help of another continually changing magnitude. This is basically nonsense. Moreover, there is an array of heterogeneous goods and services with an array of prices. Adding up cars, potatoes, movie tickets, rents, and so forth, making an ‘average’ out of the result and calling it the ‘general level of prices’ is absurd.
Just as various new calculation methods that have been adopted over the years have resulted in CPI and similar indicators (PCE is used for deflating GDP) becoming ever lower on average, the same methods have resulted in ever higher real GDP numbers. Needless to say, both effects have the side effect of tending to flatter the government’s economic policies and the Fed’s monetary interventions. Surely that is just a coincidence (cough cough).
The effects on GDP are such that it is fair to say that we are dealing with a complete fantasy number. Whatever it reflects, it is not reality and its connection with ‘economic growth’ seems almost coincidental. This is beside the fact that GDP fails to account for the vast bulk of the economy’s production structure, as we have often discussed in these pages. If one wants to know about the actual distribution of economic activity, one needs to consult gross output data.
One effect of this is that many people erroneously assume that consumption is the biggest part of economic activity. It should be clear purely from a common sense perspective that this cannot be true: if we were to continually consume more than we produce, we would soon be living from hand to mouth.
This post was published at Acting-Man on October 30, 2015.