Real real GDP

Real real GDP

We have already reported that real GDP in the United States is biased by the change in definition of the GDP deflator around 1978. (According to “Concepts and Methods of the U.S. NIPA” the growth rate of real GDP is the growth rate of nominal GDP reduced by the overall change in prices as expressed by the GDP deflator or the economy-wide price index.) Figure 1 shows that before 1978 the GDP deflator and CPI were similar and their difference is negligible since 1929. In 1978, a new definition of the GDP deflator was introduced and the curves coinciding before 1978 started to deviate. In 2010, the deviation was approximately 20%.

A reasonable assumption on the new definition of the GDP deflator is that it should also be applied to the time series before 1978. This would reduce the bias introduced in the time series around 1978. Figure 1 demonstrates (dashed line) that the growth rate of the CPI after 1978 is approximately 20% higher that the rate of the GDP deflator growth. Without loss of generality, one may assume that the GDP deflator had been growing at a rate approximately 20% lower than the CPI before 1978. In Figure 1, green line represents the GDP deflator before 1978. Since the growth rate of the GDP deflator was lower the over all change between 1929 and 2010 is also smaller than that of the CPI.

The difference between the GDP deflator and CPI has an immediate consequence as related to real GDP. When applied to the real GDP estimates published by the Bureau of Economic Analysis, the corrected GDP deflator provides a more accurate time series. One must use this corrected time series in economics and econometric research in order to avoid the apparent bias.

To begin with, we have updated our comparison of real GDP and real GDP per capita growth. This comparison has demonstrated that the fall in real GDP (recession) has actually returned the growth trajectory to the long-term trend and there is no output gap as estimated from real GDP time series. Figure 2 depicts two old and two new (corrected) curves. One can see that the new curves are above the old ones since the corrected GDP deflator is lower than the CPI and the updated real GDP estimates are higher than the original estimates. The corrected real GDP curve implies a much larger output gap that makes this hypothesis truly void. Essentially, the growth rate between 1930 and 1960 was so high that it can never be repeated. As a result, the Solow model (constant returns to scale) behind the output gap is likely to be wrong.