## 12/24/10

### Is real GDP correct?

This is an instructive story about the metrology of macroeconomic measurements. From the point of view of hard sciences, the economics profession does a great counterproductive work in order to hide actual links between macroeconomics variables. Among the most effective tools of this clandestine operation is the random change in definitions of these macroeconomics variables without mentioning it during statistical analysis.   We have devoted enough time to reveal and recover many trivial cases in our book “mecħanomics. Economic as Classical Mechanics”, but the list is too far to be closed yet.

It is well known that there is no such macroeconomic measurable parameter as real GDP (see Concepts and Methods of the U.S. NIPA for details). There are two actually measured variables: nominal GDP and GDP deflator (price index). Real GDP is estimated using nominal GDP less the change in prices. (General public usually thinks that there are real and nominal GDP estimated and the difference is called price inflation. Wrong.) The latter is not easy to calculate or even evaluate.  It is so much sophisticated problem that before 1980, there was no practical difference between the consumer price index (CPI) and the GDP deflator in the U.S., as Figure 1 demonstrates. Effectively, the curves in the Figure split in 1980. There is no direct statement about the reasons of the change in definitions in the aforementioned conceptual document, but we might guess that this is likely related to the introduction of new methodology to evaluate price inflation.

Thus, before 1980 the CPI was used as an estimate of price inflation. Since 1980, GDP deflator has been used. The difference between these two variables can not be neglected: the cumulative change in inflation between 1980 and 2009 is 20 points – the Figure shows cumulative change in inflation rate since 1929. Does that mean that when applied to the estimates before 1980, the concept of dGDP would result in even bigger change in real GDP estimates?

All in all, the notion of real GDP is a virtual one and is highly biased by the change in its definition in 1979.  One has to be very careful when using real GDP estimates in economic analysis. Do not trust the BEA before you check the comparability of their estimates through time.

Figure 1. Cumulative  rate (the sum of annual inflation rates, what is different from inflation index) of inflation since 1929, as described by the CPI and dGDP.