10/22/11

Real GDP is NOT correct

This is an extension of the story on wrong metrology of macroeconomic measurements. Economics chiefly fails and produces a great amount of counterproductive work due to wrong measurements of basic macroeconomics variables. In our previous post we focused on real GDP in the US and here we extend the case by Australia, Canada, and the United Kingdom. As mentioned before, we have devoted enough efforts to reveal and recover many trivial cases in our book “mec─žanomics. Economic as Classical Mechanics”. 
Real GDP (see Concepts and Methods of the U.S. NIPA for details) is the difference between nominal GDP and the GDP deflator (price index). The latter is not easy to calculate or even evaluate.  In this post, we found that it is so much a sophisticated problem that before 1978 there was no practical difference between the cumulative inflation values of the CPI and the GDP deflator in the US, as Figure 1 demonstrates. (The cumulative inflation, i.e. the cumulative sum of inflation rates, is different from price index when differently calibrated in the beginning.) Effectively, the curves in the Figure diverge from 1978. 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 a new methodology to evaluate the overall price inflation.  This difference has affected our analysis of Okun’s law and forced the introduction of a structural break in 1978 in the dependence between unemployment (and employment) rate and the rate of real economic growth. As we lately reported, this was an artificial break completely related to the change in real GDP definition in 1978.  
Thus, before 1978 the CPI was used to estimate of the overall price inflation. Since 1978, the GDP deflator has been used. The difference between these two variables can not be neglected: the cumulative change in inflation between 1978 and 2009 is 20 percentage points. This implies that when applied to the estimates before 1978, the concept of the dGDP would result in a bigger change in real GDP estimates. The overall real GDP increase since 1929 should be much larger in the current definition of the GDP deflator is applied.   
To validate this finding we have borrowed data from the OECD and calculated the CPI and dGDP cumulative inflation in Australia, Canada and the UK, as shown in Figure 2. There are clear breaks in different years: for Australia in 1983 (also 1983 was estimated from a structural break in Okun’s law); for Canada – 1980 (1982 was estimated from a structural break in Okun’s law); for the UK – 1979 (1982 was estimated from a structural break in Okun’s law). For the UK, the CPI and dGDP curves start to diverge in 1979 but the pace of deviation is very slow and the year of structural break in Okun’s law is hard to determine accurately.
One can conclude that all structural breaks in the previously estimated models of the rate of unemployment (Okun’s law) and the employment/population ratio for the US, Australia, Canada and the United Kingdom were entirely artificial and forced by the change in real GDP definition in the years of these breaks. (The OECD does not provide sufficient data length for other modeled countries and we need to find other sources of information for France, Japan and Spain.) Hence, real GPD estimates are incompatible over the break years and thus wrong. One must not use them for modeling and statistical analysis.  
Real GDP is NOT correct!
Figure 1. Cumulative  rate (the sum of annual inflation rates, what is different from inflation index) of inflation in the United States since 1929, as described by the CPI and dGDP.
Figure 2. Same as in Figure 1 for Australia, Canada and the United Kingdom.

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