Sunday, October 26, 2008

Supply-Siders: Inflation Is Growth

Steve Forbes had a column whose basic message was that although government intervention had created some problems now, free markets had over a longer period created great wealth and that if the politicians don't overreact then the economy will recover. I basically agree on that, although I think he underestimates greatly just how much damage the interventions already undertaken will cause, and therefore think he is too optimistic about the prospects for an immediate recovery even if the politicians restrain themselves. What I however thought was most interesting and misleading was this part:

"Even in recent years the much-maligned U.S. did well. Between year-end 2002 and year-end 2007 U.S. growth exceeded the entire size of China's economy. Obviously China's growth rates were higher, but China was coming off a much smaller base."

China's GDP in 2007 was 24.67 trillion yuan
, which with the exchange rate on December 31 of 7.2946 is roughly $3.4 trillion (with today's exchange rate it is more like $3.6 trillion). Q4 2007 U.S. GDP was $14.03 trillion, and cumulative real growth between Q4 2002 and Q4 2007 was 15%, meaning that cumulative real growth with Q4 2007 dollars were $1.83 trillion, only slightly more than half of China's GDP. The only way in which Forbes can be right (sort of) is if we look at nominal growth, as nominal GDP rose from $10.59 trillion in Q4 2002 to $14.03 in Q4 2007, an increase of $3.44 trillion. But using nominal numbers in such comparisons are highly misleading as that treats inflation as growth. In case it is not immediately obvious why that is wrong, remember that if we use nominal growth numbers to represent economic growth, that would make Zimbabwe the fastest growing economy in the world.

Nor is this the first time this has happened. Larry Kudlow back in 2006 also used a similar comparison with the Chinese economy by comparing it to nominal growth.

Even while claiming to be anti-inflation, supply-siders are in practice usually pro-inflation (with some exceptions). Their use of nominal growth numbers to represent economic growth could therefore perhaps be interpreted as a form of Freudian slip revealing their inflationary bias.


Anonymous newson said...

hence steve forbes frantic warnings in the midst of the tech bubble that greenspan was running a deflationary monetary policy! he merely was reading the gold price as the ultimate arbiter of inflation/deflation, as opposed to looking at the cpi, as most supply-siders do.

4:32 AM  

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