Unheeded Lesson

After doing their usual GDP autopsy in “It May Sound Disappointing But It’s Not!”, Thomas Cooley and Peter Rupert write:

It is clear that the U.S. economy is continuing to grow. That consumption and basic investment are strong is a sign that the domestic fundamentals are pretty strong. Real disposable personal income increased by 3.5%. Declines in the energy sector have held back investment in non-residential structures and equipment and that doesn’t promise to improve in the near future…

… There is a growing chorus of people who believe that they are doing unseen harm by not normalizing monetary policy. There will be a couple more employment reports and the second estimate of Q3 GDP before the next FOMC meeting in mid-December, so time and data will tell!

Now for the unheeded lesson: GDP=C+I+G+(X-M)=Grossly Deceptive Partitioning:

When I discuss the effect of monetary stimulus on aggregate demand with other economists, I notice that they often want an explanation couched in terms of the major components of GDP.  I find this very frustrating, as this approach does more to conceal than illuminate…

… Macroeconomics should be about aggregates, not components of spending.  Yes, changes occurring in the various components of GDP can impact interest rates, and thus velocity.  And if monetary policy is inept (i.e. doesn’t offset changes in velocity) that can impact nominal spending, but it certainly isn’t the most illuminating way of looking at the issue.  It’s like trying to explain changes in the overall price level by modelling changes in the nominal price of each good—theoretically possible, but a waste of time.

And what are the aggregates saying? They are reflecting the visible harm monetary policymakers are making through tightening monetary policy by “word of mouth”!

Echoing Friedman, Bernanke once said: To gauge the stance of monetary policy, look at what´s happening to nominal spending (NGDP or Nominal Final Sales, for that matter) and inflation.

And the message is clear!

Pill to swallow

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