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Where Is this U.S. Recession Already?

August 29, 2008

Note: This piece is by Christian Menegatti of RGE Monitor, where this piece first appeared.

So, good news on the real U.S. GDP growth front: 3.3% in Q2 2008. But is it really good news? Let’s dig a bit deeper, maybe past the headlines…

Personal consumption was revised slightly upward from 1.5% of the advanced release (adv) to 1.7%. Not a major change. Notwithstanding the stimulus package consumption failed to stay above 2% (in 2007 it averaged about 2.3%) and continues to grow at the slowest pace since 1991.


Gross private domestic investment was revised upward (from -14.8% to -12%), but remained a drag on GDP contracting at a pace consistent with the one seen in the two previous recessions (1991 and 2001) (the biggest negative contribution to GDP growth in Q2 -1.82%). The improvement is explained by the change in inventories that were less of a drag than previously estimated (their contribution to growth was revised from -1.92% up to 1.44%). Residential investment were basically unchanged with respect to the advance release, (-15.7% versus -15.6%), this is an improvement with respect of an average of about -24% in the previous three quarters.


So, what explains the upward revision? Largely the external sector.

Is this really good news?

Net export contributed to 3.1% of the 3.3% growth. The real growth rate of export was revised upward from 9.2% to 13.2% (and the contribution to real GDP growth from 1.16% to 1.65%). The real growth rate of imports was revised downward from -6.6% to -7.6% (and their contribution was therefore revised up from 1.26% to 1.45%).

These numbers expose the weakness of U.S. domestic demand which is clear from both the performances of personal consumption and imports (both on the consumer side and on the industry side), although the weakness in import enters as a positive contribution to GDP – note that the positive contribution to GDP that came from the slump in imports was larger than the one of personal consumption (1.45% versus 1.24%). Moreover, exports win the medal from the strongest contributor to growth this quarter, with a contribution of 1.65%.

But will this continue?

A few weeks back we surveyed a group of countries navigating towards (or through) recession. The list included the U.S., Canada, Spain, Ireland, Italy, the UK, the Baltics and New Zealand.

Now the growth engine of the EMU, Germany, is faltering, together with France. And a recession might be in the works for Japan as well. This essentially leaves us with a fully fledged G7 recession in the making.

Canada, Europe and Mexico are the biggest export destinations for the U.S. Now with this reassessment of the global outlook, Canada, Europe (as well as Mexico) navigating towards a downturn and the USD in strengthening mode against the EUR and the CAD the support of exports might go missing in the next few quarters. Moreover, personal consumption will not benefit from the stimulus package anymore and its growth might very well turn negative.

Another important data point today came from the income side of the economy. Adjusting nominal gross domestic income for inflation shows a growth of 1.9% for Q2 2008. Note that these figures already experienced two consecutive quarters of contraction in Q4 2007 and Q1 2008. These figures suggest that the growth rate of the U.S. economy might be much weaker than what signaled in the GDP figures. Gross domestic income is a figure closely watched by the Fed.

One more element of the report worth mentioning is the fall in corporate profits. For the fourth consecutive time corporate pre-tax profits (with inventory and capital consumption adjustments ) declined 2.4% (quarterly) ($37.8bn) in the second quarter after falling 1.1% ($17.6bn) in the first quarter and are down 7% since last year, the worst since 2001.

Profit from domestic industries dropped 1.9% in Q2 after rising 0.5% in Q1. The entire decline came from a 6.0% fall in nonfinancial industry profits.

So much for the good news…


  • Posted by Dave Chiang

    Part of the reason the GDP number looked so good was because the GDP price index for the second quarter was marked at just 1.2. In other words, BEA subtracted from nominal GDP 1.2% in order to produce their version of “real” (inflation-adjusted) GDP.

    [Mish Note: The CPI is running at 5.6%. A reasonable person would have expected the GDP deflator to be somewhere near 5.6% as opposed to 1.2% but a reasonable person would have been wrong. GDP would have been negative if a lager deflator was used.]

    Hedonics And Imputations

    Of course one needs to add hedonics and imputations to the list of GDP distortions. Imputations are a part of GDP that the government decides to estimate value, where no cash actually changed hands. In other words, if I scratch your back and you scratch mine but no one gets paid, then back scratching is undercounted in the GDP.

    One such imputation is the value of “free” checking accounts. The reality is bank checking accounts are not free. Banks are sweeping out nearly every penny every night and lending the money out. What’s “free” is banks having free assess to your money. Nonetheless the BEA assigns a value to those free checking accounts and adds it to the GDP. Given that nearly every adult in the country has a checking account, the amount is non-trivial.

    It goes far beyond that however, into complete fairy tale absurdities. For example: If you own your own house, the government recalculates your income as if you were really renting from yourself and paying yourself rent.

  • Posted by anon

    A lot of hacks are disputing the validity of the low GDP deflator in these numbers, such as noted above.

    It would be helpful if the RGE economists or Brad Setser could weigh in on this and set the record straight from the viewpoint of the professionals.

    I believe the correct explanation is that the deflator excludes import inflation, which has been very high. And it should exclude import inflation, because GDP excludes imports. The fact that the deflator is low means that domestic content production is very healthy in terms of containing inflation pressures in output for both domestic consumption and exports. It is particularly good for export competitiveness.

  • Posted by Cedric Regula

    One technical point, the BLS boys do have a valid reason to use their own deflator rather than the CPI. A domestic product deflator adjusts for price inflation of domestic produced goods. So an inflation measure like CPI that includes oil prices would give an inaccurate picture.

    But the 1.33% deflator they used is nuts, and can only be a result of arm waving hedonics.

    The real question is should we like a growing GDP?

    Well, we are exporting our tax subsidized food, and our military. We have growth in “government services” paid for by an increasing federal deficit. Next day we see the personal income data looks bad. So we can conclude that being a military-agricultural complex is not good for the country.

    So Ron Paul may know what he is talking about after all, even though he is routinely dismissed as a quack and a malcontent in Washington DC.

  • Posted by anon

    Import inflation is running at a massively high level – lots of leverage there in terms of transforming a high CPI to a low GDP deflator. On this issue specifically, hedonics is a red herring; although it is certainly a contentious and debatable issue at the more general level of inflation measurement methodology.

  • Posted by Devin Finbarr


    What reason do you have for even looking at the GDP statistic? David is right – the number is completely made up.

    Take hedonics and chain weighting the prices – both attempts to measure changes in quality over time. But these changes in quality are impossible to measure numerically. For instance, how many times better is a 2002 desktop computer than a 2008 computer? One person may say that the 2008 model is 5 times better, because the processing power is 5 times greater. Another person might say that they are equal, because they only use Microsoft Word, and that works equally well on both computers. A third person might say that the 2008 version is worse, because Vista sucks and crashes constantly. The judgment is entirely subjective. Plausible arguments result in an order of magnitude difference in the result. And yet, numbers like these are actually used to determine the GDP. Every component of GDP is this bad. Which is better an average 1970’s house – ( 1,300 ft, 15 minute commute, in a neighborhood with a very high walkability index) or the average 2008 house ( 2,200 square ft, 25 minute commute, have to drive everywhere)? Which is better, Grey’s Anatanomy or a Vaudeville Show? Thanks to Napster/BitTorrent/NetFlix, the average person has an infinite supply of music, tv, and movies. Is that an infinite gain in wealth? Of course, Napster and the Internet seemed to have killed the music industry, and no great bands have arrived on the scene since the late 1990’s. Since I love guitar rock, this is a terrible loss for me.

    For most items comprising the CPI basket of goods, plausible arguments could be made that result in not only order of magnitude difference in growth, but an actual change in direction of growth. Yet magically, the number comes out to consistently be 2-3% a year. It’s not a conspiracy, but it’s obvious the number is purely the creation of a messy political process.

    What happens is that every so often people subjectively feel that the number is wrong. For instance, in 1995, measured inflation was causing social security payouts to go out higher than people thought were necessary. So the Boskin Commission found plausible arguments for reducing the inflation number. I am sure that when they figured out all these hedonic and chain-weighting measures, the committee members simply kept adjusting the model until the numbers looked right.

    The number is so divorced from reality that our cities can turn into desolated war zones ( the 1970’s) or the internet can give us an infinite amount of entertainment for free, and neither makes much of a blip in the GDP number.

    What’s more, the actual method used to determine increase in quality – chain weighted prices – does not measure increase in quality at all, but measures the fact that people will consistently pay more for the newest item regardless of whether it is any better. The newest fashion accessories always sell for 20% more than last seasons, but no one argues that fashion increases in quality by 20% a year. The GDP number is essentially based on this constant, “status factor”, and mixed and adjusted with other fudge factors, and ends up consistently growing 2-3% a year no matter the economic conditions.

    It’s simply astounding that economists run so many regressions against the GDP number, when it was so obviously designed by a subjective, political process.

    If you really want to track changes in the standard living over time, statistics can certainly play a roll. But you have to use your brain. If I was studying the changes in the standard living, I would look at each part of a person’s budget individually. I would make an objective comparison of price of good versus median income. For instance, I’d look at the price of eggs or flour or fish versus median income over time to see how much richer in terms of food we were. I’d then subjectively compare the offerings in a typical super market today versus 1950. I’d look at the price of the median home compared to median income in 1950, versus today. But then I’d also have to subjectively compare the size of the home, location, commute, etc.

    Statistics, such as median income or the price of eggs, can be very useful in combination with subjective comparisons. But many of the models of modern economists use junk statistics and get junk results.

  • Posted by Cedric Regula

    I don’t have a massive amount of data to back up what the deflator should be but, think about what American made stuff you buy.

    2)Electricity – going up 30% here next year.
    3)Refined oil
    4)Haircuts are up another buck
    5)My car insurance went up 7% for no reason
    6)cable has been on the rise
    7)Then the biggie – health care and dentists
    8)minimum wage has been kicked up
    9)movie tickets up
    10) Cover charges at the night club went up

    There is probably more, but thats off the top of my head quickly.

  • Posted by anon

    Cedric Regula,

    Fair enough, but you’re really making an argument about CPI, not about the deflator, and not about the difference between the current measure of CPI and the deflator.

  • Posted by anon

    Devin Finbarr,

    Really excellent comment.

  • Posted by Cedric Regula


    I don’t think so, unless I’m wrong of course.

    My thinking is that the deflator is a subset of the CPI, i.e. it excludes imports.

    So things like insurance, health care, food and haircut prices would be at least a proxy for domestic inflation.

    I haven’t checked on the prices of Boeing aircraft or Caterpillar tractors, so maybe they are plunging in dollar terms. Just kidding. I don’t really believe that.

  • Posted by anon

    Cedric Regula,

    Not quite. The deflator is not a subset of CPI. Although it excludes imports, it includes exports (which the CPI excludes).

    As I said, import price inflation is massive (although not a widely reported number, I believe it has approached 20 per cent recently). E.g. inflation on the imported oil content of refined gasoline is excluded from CPI. Only the value added is included. And the value added might even be deflating (at times). So refined gasoline related CPI in theory could be deflating while oil is inflating.

    The US imports about $ 1.8 trillion. Whatever the inflation rate on this, it is included as a big inflation hit in the CPI calculation but excluded from the GDP deflator calculation. This mostly accounts for the large difference between CPI and the deflator (I believe that export inflation is better behaved).

  • Posted by anon

    Cedric Regula,

    Sorry for last confusion. Second paragraph should read:

    E.g. inflation on the imported oil content of refined gasoline is excluded from the GDP deflator. Only the value added is included. And the value added might even be deflating (at times). So refined gasoline related GDP in theory could be deflating while oil is inflating.

  • Posted by Cedric Regula

    Well, I think we are really talking about the same thing. I’m having trouble thinking of any commercial products of ours that are exported, but not also sold in the US. The drug industry has a two tier pricing structure, but that’s another story.

    I think value added gets factored into everything, i.e if minimum wage and new health care costs push up store operating costs at Wal-Mart, that is in the deflator. Wal-Marts increased cost of Chinese stuff is not.

    I think where you may be getting hung up on is in gibving meaning to the magnitude of difference in the CPI and the deflator.

    People have been tracking what the CPI should be today, if calculated the way it was done before the hedonics ’90s.

    They conclude it would be 3% higher, or 8.5%.

    So if I said that the CPI is 8.5%, and the deflator should be 4.33%, would that be more believable?

  • Posted by anon

    That’s fine and that’s my point (although the spread would compress moderately as the CPI is restated higher). I’m not focusing on the hedonics effect per se here.

  • Posted by anon

    i.e. my point is that most of the criticism on the blogs is conflating a debatable proposition about hedonics type effects with an undebatable proposition about why the deflator should be different than CPI

  • Posted by Cedric Regula

    The bad news is we’ve just concluded that we have zero GDP growth, and an increasing federal deficit to get to zero.

    But that’s why I’m not in the stock market right now.

  • Posted by anon

    Growth is in the eye of the beholder – like inflation.

  • Posted by algernon

    The CPI, manipulated to understate as it is, better expresses the loss of the value of the US$. The US$ is the unit of measure of GDP. Prima facie, GDP is negative.

  • Posted by Cedric Regula

    So are stock market crashes.

    I’ve just been thinking as result of this about previous recessions. 2001-2002 routinely gets compared to 1991 and 1980-1981 recessions.

    But 2001-2002 was our only post hedonic recession and it is usually brushed off as a mild one on the basis of data that is clearly not consistent over the years.

    What if it really was a gut wrenching recession? What if business leaders and policy makers really did use data like this for decision making, leading to misreading the economy?

    Worse yet, what if Noriel Roubini gets proven wrong on his recession call due to phony data?

    How can we live with that?

    Also, I really don’t like having to manage my little next egg based on my personal observations of haircut prices!

    This must end!

  • Posted by anon


    Cedric Regula,

    I posted the following on Big Picture this a.m.:

    There are lots of reasons to question the data and its interpretation.

    But there’s a tendency to conflate somewhat different dimensions of the problem.

    E.g., some aspects frequently noted:

    a) CPI hedonic adjustments


    b) GDP “contra entries” e.g. imputed rent as output and income

    c) GDP financial sector profits, which probably exclude asset write-offs from underlying GDP income calculations


    d) The GDP/GDI differential


    e) The CPI/GDP deflator differential
    The last of these should be the least controversial if interpreted probably. Most of the difference between CPI and the deflator should be attributable to the exclusion of import inflation from the GDP deflator calculation. Import inflation is currently extreme. CPI inflation, although probably understated for many reasons discussed, is made higher than what would otherwise be the case because of import inflation.

    GDP includes only the valued added by the US economy in the further processing of imports. So the lower deflator number (leaving aside the other contentious CPI calculation issues noted above) means that the US economy is inflating in terms of total value added at a slower pace than imports per se (e.g. refining margins within the US inflating less than imported oil itself).

    It’s a messy subject, but it doesn’t really advance the case for CPI criticism by conflating that issue with what should be an understandable difference between the scope of CPI and the scope of the deflator. In particular, I don’t think it’s quite accurate to suggest that the deflator as an inflation measurement is the primary driver of understated inflation or overstated GDP. The other sources of the problem are closer to the truth of the problem, in my view.

    Posted by: anon | Aug 30, 2008 10:30:13 AM

    I agree Westbury’s “import adjusted GDP” is a back-asswards way of looking at the problem, resulting in an absurd concept for GDP.

    But the point he makes is that such an absurd GDP interpretation is in fact the logical consequence of what is an equally absurd inflation adjustment – which is to attempt to deflate GDP with the CPI.
    His final paragraph is more directly to the point, and is consistent with what I wrote above at 10:30.

    Posted by: anon | Aug 30, 2008 10:46:11 AM

  • Posted by RebelEconomist

    Readers of Brad’s blog may recall that I have often criticised the US inflation measures as understating inflation, but anon is right. The difference between the GDP deflator and the cpi is not unreasonable. Essentially, US product prices are not increasing much despite rampant commodity price rises, so in that sense, the US economy is performing well. For a deeper explanation, I recommend reading the econbrowser post on this subject:

    In my view, the least defensible aspect of the inflation measures used by the Fed is quality adjustment, which is applied to both the cpi and the GDP deflator. I also think that the Fed arguments about not targeting asset prices are specious, although I would not want them to start here. Please don’t let US economic policymakers off the hook by making criticisms that are easily answered.

  • Posted by flow5

    Calculating the rates of change in the CPI has been statistically exaggerated by the present practice of calculating the rates of change in terms of a base one year earlier, rather than from the base period of the index. For example, when I first started driving the base period for the CPI was 1967 = 100. Consumer prices in 1967 have increased 623% in terms of base year prices. In other words, a very substantial absolute increase in prices. But the base period keeps changing. Now the base period is 1982-84 = 100. And that assumes that the CPI is representative, which, as everyone knows, it is not.

  • Posted by Rien Huizer

    Interesting article with interesting comments. Clearly, national accounts are a flawed instrument for intertemporal measurement of economic performance within the same country and even less so for cross country comparisons. From a politics point of vie, the three key numbers are:
    (1) household consumption (people do not like the world when that goes down), household asset prices (especially houses) and employment (high employment means worker bargaining power, hence consumer confidence).

    GDP has something to do with all of this, but not in a very straightforward way. Hats off for mentioning the importance of GDI for monetary policy decisionmakers.

  • Posted by Cedric Regula


    I do wonder about cross country comparisons.

    Does the ECU enforce a common methodology on members, at least for major stats tracked by Forex and others, like GDP, employment, “inflation”, deficits and government debt?

    I’ve heard the Euro stats may track reality better than US stats, but I have no idea what to believe.

    Some think Italy and maybe Spain are serious default risks. Any opinion on that?

    Also, about GDI, I saw somewhere stating that it includes home equity withdrawals. But maybe that’s what you meant.

  • Posted by anon

    No way does GDI include home equity withdrawals.

  • Posted by RebelEconomist


    I am usually interested in your monetary comments, but in this case I do not see what you are getting at. I assume that you are saying more than that there has been less inflation over a shorter period…..what matters is the inflation per year, right? Perhaps you are saying that if the basket is changed more frequently, measured inflation is lower?

  • Posted by anon


    New post on Big Picture this a.m. picks up on the GDP deflator/CPI debate

    My response there:

    I see you’ve spent some time reconsidering the analytical aspect that was the point of my comment and your response on your previous post.

    This is not “a bizarre and counter-intuitive outcome”.

    And it does not make “GDP appear better than it really is.”

    And there are not “inherent biases”.

    This IS the calculation of inflation for GDP.

    What you are getting around to focusing on is the difference between the scope of CPI inflation and GDP inflation. You have to understand that in order to appreciate why none of these negative allegations above are true, at least with respect to this particular issue.

    CPI will reflect imported oil inflation plus the inflation in any refining margin that is part of (domestic) US GDP.

    The GDP deflator will include only the refining margin inflation component. It excludes the imported oil inflation, because imports are not part of GDP.
    Therefore, the difference between CPI and the GDP deflator is the exclusion of a large imported oil inflation component from the GDP deflator.

    So if imported oil inflation is very high relative to GDP inflation, the CPI will be pushed up above the GDP deflator but below imported oil inflation.

    In general, the rising scale of [GDP deflator; CPI; import inflation] will depend on the various inflation differentials and the weighting of imports.

    Imports run about $ 1.8 trillion relative to a $ 14 trillion GDP.

    Import inflation runs 20 per cent or even more currently.

    That’s a significant factor that shows up in CPI but not in the GDP deflator.

    The model does not “raise GDP”.

    It’s not a model. It’s measurement, at least on this issue.

    And the measurement recognizes that GDP inflation is most certainly not the same as CPI inflation – the scope of the measurement is entirely different.

    This was also Wesbury’s point.

  • Posted by Devin Finbarr

    I’m curious about the rationale for not including import prices in GDP. On one hand, it’s understandable that you’d want to measure only domestic production. If a car factory in Japan gets swallowed in an earthquake, thus driving up the price of cars, that clearly is not a case of lower domestic production.

    On the other hand, if foreigners decide that they no longer value American goods – say they decide they do not want to buy American financial products – and that drives up the exchange rates, making foreign goods more expensive, then that does represent a decline in the U.S. GDP. That means that U.S. domestic production was much less valuable than it was in previous years.

    Since the rising price of imports has been due to the second scenario, it makes sense that imports should be counted as part of the GDP deflator.

  • Posted by anon


    Devin Finbarr,

    Not sure I understand your question, but a few points:

    a) “American financial products” per se aren’t part of anybody’s GDP. They’re a flow of funds rather than GDP output (but this example is beside the point).

    b) Most US domestic production isn’t valued according to the external value of the dollar. The dollar only affects the foreign value of exports and the domestic cost of imports.

    c) The dollar is down which tends to make imports more expensive. And oil is up as well. The combination affects import inflation mightily.

    I think in the end however you may be confusing the GDP deflator, which is a measurement of inflation, with the idea that GDP has contracted or been deflated, at least at the margin, as a result of import inflation. In fact, quite the opposite has happened. Import inflation tends to correlate with export competitiveness when looking just at the dollar. And exports have been growing and were the big contributor to recent reported GDP strength.

    Sorry if I misunderstood your point.

  • Posted by Rien Huizer

    I believe (but not sure) that Eurostat has a standardized pproach to national accounts. But that does not mean that all EU members comply and also, things like CPI are very country specific. Luxemburg with the world’s highest GDP per capita (I hope I am right) does not have the same basket as Rumania… But, EU sttistics are more insulated from political interference than US ones, I would expect.

    Italy and Spain will default tomorrow, or perhaps they will wait a while. I would personally consider an Italian default vindication, but I am sure it will not happen in our lifetime.

  • Posted by mheck

    Spain is very far from default. There public debt as share of GDP is very low. Lots of private debt doesn’t make your country default.

    Italy is a completely different story. They have a huge public debt load. There politicians are probably the most corrupt in the EU and the Mafia has incredible power. I wouldn’t bet my life on Italy’s credit worthyness.

  • Posted by Devin Finbarr


    To be a little more clear, let me take “financial product” out of the equation. Instead considering the following scenario:

    Imagine toy economic system where America sells the country of Chirabia cotton and Coca-Cola, while Chirabia sells America oil and electronics.

    Chirabian consumers wake up one day and realize that Coca-Cola is not a magic substance that makes you happy, rather, it is just flavored sugar water. Incompetent American management had taken all the coca out of Coca-Cola, making it far less valuable to the Chinese. As such, the demand curve changes, and the Chinese refuse to pay any more than $1 for Coca-Cola.

    Since exchange rates must balance, the price of cotton and Coca Cola as sold to the Chirabians would go down. The quantities of cotton sold would increase, and the quantities of Coca-Cola sold would decrease or stay the same (depending on the exact structure of the supply and demand curve). The price of oil and electronics to Americans would go up, and the amount purchased would go down.

    Americans would experience this as “import inflation” and a “falling dollar”. However, what really has happened is that a certain American produced product has substantially decreased in value. The new Coca-Cola no longer makes people happy and foreign demand for it has slackened. This means it is harder for Americans to buy Chirabian products.

    Thus, overall, this example shows how “import inflation” can result from a decline in domestic production. Perhaps, then import inflation should be included in GDP deflator calculations.

    My questions would be:
    1) Is this scenario a fair criticism of the GDP calculations?
    2) Is this scenario analogous to what is currently happening?

  • Posted by Cedric Regula

    I think you’re questioning whether GDP growth means anything good, necessarily.

    You are not the first. And if we export tax subsidized cotton and crappy Coca-Cola made by illegal aliens, it’s even worse.

    But here are what some economists don’t like about it.

    * Austrian economist critique – Criticisms of GDP figures were expressed by Austrian economist Frank Shostak[1]. Among other criticisms, he stated the following:

    The GDP framework cannot tell us whether final goods and services that were produced during a particular period of time are a reflection of real wealth expansion, or a reflection of capital consumption.

    He goes on:

    For instance, if a government embarks on the building of a pyramid, which adds absolutely nothing to the well-being of individuals, the GDP framework will regard this as economic growth. In reality, however, the building of the pyramid will divert real funding from wealth-generating activities, thereby stifling the production of wealth.

    Austrian economists are critical of the basic idea of attempting to quantify national output. Shostak quotes eminent Austrian economist Ludwig von Mises:

    The attempt to determine in money the wealth of a nation or the whole mankind are as childish as the mystic efforts to solve the riddles of the universe by worrying about the dimension of the pyramid of Cheops.

    Simon Kuznets the inventor of the GDP, in his very first report to the US Congress in 1934 said[2]:

    …the welfare of a nation [can] scarcely be inferred from a measure of national income…

    In 1962, Kuznets stated[3]:

    Distinctions must be kept in mind between quantity and quality of growth, between costs and returns, and between the short and long run. Goals for more growth should specify more growth of what and for what.

  • Posted by anon

    Devin Finbarr:

    Imports are simply not part of GDP, and therefore import inflation is not part of the GDP deflator.

    The GDP deflator simply translates nominal GDP to real GDP by subtracting or deflating it by the appropriate inflation measure, which excludes import inflation, because GDP excludes imports.

    And the deflator is not necessarily an indicator that either nominal or real GDP is contracting. My sense is that this may be a point of confusion for you.

    Import inflation may be associated with many different types of GDP changes, including reduced domestic margins, increased domestic prices, changes in domestic demand, or sympathetic changes in export pricing and activity. The possibilities are endless. Recent import inflation has been accompanied by an increase in exports and real GDP growth via exports, partly due to the lower dollar.

    The point I think is that the idea of the GDP deflator is simply a measurement of GDP inflation, which excludes import inflation, notwithstanding the many indirect consequences or associations import inflation may have for domestic pricing changes and the deflator.

  • Posted by anon

    I wouldn’t blame the definition of either GDP or the deflator for any failure to analyse their components properly.

    This is a variation of the problem of the person with a hammer, for whom every problem looks like a nail.

  • Posted by RebelEconomist

    Devin Finbarr,

    (1) I am not sure that your example does represent a criticism of the GDP calculations. If an American product declined in quality but had an unchanged price in dollars, its quality-adjusted price would have risen, so deflated US output would be appropriately lower.

    (2) I do not think your scenario is analagous to what is currently happening. The key development is that import prices have simply gone up, because, as far as the US is concerned, the supply of commodities has contracted – essentially because other parts of the world are now consuming more (your model might be better with China and commodity producers split). It’s not that American products (and those of the rest of the developed world) have got worse; it’s just that the competition has got tougher. If we want to maintain the same standard of living, we must produce more or better than before, because the terms of world trade have moved against us. What worries me is that people in the developed world find it hard to accept that things can get worse without anyone having done anything wrong, and are liable to vote for politicians who at best deny the need for adjustment and at worst offer damaging populist solutions like protectionism.

  • Posted by JSmith

    Delong is seeming to be rather prescient.

    It does appear that the Chinese will opt for inflation rather than revaluation.