Monday, June 30, 2014

Confusion and Context

Tracking down Y = C + I + G + NX, I came across an old Steve Roth post: Why Does Y Equal Real GDP?. Roth and correspondents get into a lot of discussion that I want to skirt. My motivating question was: Does the Y represent real GDP or nominal GDP (or does it perhaps represent real output, which is not really the same as any GDP)? Short answer: It seems to be ambiguous at best. That'll do for now.

While I was reading Roth's post and some of the comments I got distracted by a different thought. Let me take you through it.

Roth opens by looking at two macroeconomic identities from a Nick Rowe post. The first of these is the National Income Identity:


C is consumer spending. I is business investment spending. G is government spending. And NX is net exports.

Later in the post, Roth quotes Saturos:

Matt Yglesias ( has a new post in which he takes Scott Sumner’s version: MV = C + I + G + NX. That might be the best approach of all – it shows you that all the changes in “income accounting” variables that get reported on the news must all be manifestations of fluctuations in the overall volume of spending, MV.

(Yglesias says Y represents "real output" but doesn't say whether he distinguishes "output" from GDP. The difference? Output is output; GDP is a measurement.)

It stops me cold when Saturos refers to "the overall volume of spending, MV."

Now... Nobody's identifying any FRED series here, so everything is much like the meaning of Y: Ambiguous at best.

Usually, though, M is some quantity of money, maybe FRED's M1 or M2, and V is the value you get when you divide nominal GDP by the M you are using. So MV (or M multiplied by V) is really

The M's cancel out, and you're left with nominal GDP. (This does not answer Steve Roth's question; rather, it seems to be what gave rise to it.)

Back to Saturos. Saturos says MV is the overall volume of spending. And we have just seen that MV is equal to nominal GDP. Therefore, Saturos is saying nominal GDP is the overall volume of spending. That's what stopped me cold.

Nominal GDP is NOT the overall volume of spending. It is the overall volume of final spending, with none of the "intermediate" spending. Nominal GDP is just the cream on top, not the whole bottle of unhomogenized milk. Got it?

Farther down, in the comments, Steve Roth replied to Andrew. Roth wrote:

GDP = Total dollars spent = MV

Again, this is not correct. GDP is not total spending. GDP is final spending only.

Total spending includes both final and "intermediate" spending. GDP includes the final spending, but excludes the much larger intermediate spending. Why count only final spending? Because final spending is the cream, that's why.

I'm not picking on Roth and Saturos. Everybody makes this mistake. I've even seen it in the New York Times. But here's the thing: I'm in the middle of trying to define a measure to use as context, so that I don't have to use GDP all the time. I want to move from using GDP -- the sum of final spending -- to using a much broader measure. For my "context" variable, I want to use the sum of total spending, not the sum of final spending.

People who think GDP is a measure of total spending will never understand.


The Arthurian said...

At Five Short Blasts, Pete Murphy writes:
Let’s get back to measurements of economic growth and begin with a look at economists’ favorite measurement, Gross Domestic Product, or GDP. It’s the measure of all of a nation’s economic activity.

Economic activity is activity that is measured as dollars of spending. (The economy is transaction, I always say.)

Economic activity is spending.

GDP is "the measure of all of a nation’s economic activity", Pete Murphy says. In other words: GDP is the measure of all of a nation's spending.

No. GDP measures output, not spending.

The Arthurian said...

At The Slack Wire, JW Mason writes:
... The first line of the table below shows total demand in each -- that is, all private consumption, government consumption, and investment -- in billions of euros. (As usual, this is final demand -- transfers and intermediate goods are excluded.) So, for instance, in the year 2000 all spending by households, firms and governments in Germany totaled 2.04 trillion euros.

Mason puts the word final in italics for emphasis, but then goes back to saying it wrong. Would it really have killed him to say it like this:

So, for instance, in the year 2000 final spending by households, firms and governments in Germany totaled 2.04 trillion euros.

"Final spending" is not the same as "all spending".