![]() ![]() You might argue that Jay Powell doesn’t know when I go out to buy something, so the lack of monetary offset is a plausible assumption. How can they learn what actually happens if they are taught that consumption is part of GDP, so spending more causes GDP to rise? But the fact that students are taught the wrong explanation means that they never really learn macro, even if they are absolutely straight A students, the best in their university. I think you see why we don’t teach students this way. ![]() And because people have money illusion, they are fooled into thinking that work has become more lucrative, and so they decide to work more. This causes the total dollar value of spending (NGDP) to rise. If we were honest with students we’d say, “Spending more might cause Jay Powell to screw up while doing his job at the Fed. So it’s just possible that consumption does boost GDP, but not for the reason you were taught in school. For an increase in NGDP to boost RGDP you also need the assumption of sticky wages. If more NGDP always did cause RGDP to rise, then Zimbabwe would be the world’s richest country. Perhaps velocity rises by more than M falls-they screw up.Įven if NGDP does increase, there’s no necessary increase in RGDP. That might happen, but in that case NGDP is not rising because “C is part of GDP”. For your decision to get a haircut to boost NGDP, the Fed must respond incompetently, allowing aggregate demand to go off course. There’s some growth rate in NGDP that best meets the Fed’s mandate. Even if the optimal NGDP growth rate is not constant, it surely doesn’t depend on whether you decide to go get a haircut. The Fed is supposed to keep NGDP growing at rate that best allows it to meet the dual mandate. The first assumption requires an incompetent central bank. First, more consumption must boost nominal GDP. In order for consumption to boost GDP, we need two assumptions to be met. There has to be some other indirect effect, which needs to be explained. ![]() ![]() But in that case the reason my income goes up has nothing to do with the claim that my consumption of haircuts is “a part of my income”. Getting a haircut might make my income go up because I look more presentable and find it easier to get a job. But if GDP does rise, it is for reasons that are completely unrelated to the myth that consumption is a part of GDP. Now it’s certainly possible that my decision to get up off the couch and go buy something does in fact cause GDP to rise. The decision to consume more only causes GDP to rise if it causes production to rise. (GDP may rise slightly, as my decision to buy the good boosts retailing services.) Rather investment falls by the value of the good, as inventories fall. If I go and spend $100 on a new product, it doesn’t cause GDP to rise by $100, even if the good is domestically built. GDP measures aggregate production, and consumption is obviously not production. But it isn’t-consuming adds to C and subtracts from I (inventories). That makes it look like consumption (C) is a part of GDP. In the textbooks, GDP = C + I + G + (X-M) The first claim is obviously plausible (assuming I find employment), while the second claim would require some pretty fancy footwork to justify. My decision to get more frequent haircuts will cause my income to rise. My decision to earn more wages will cause my income to rise.Ģ. So let’s look at some statements with real implications:ġ. Of course that’s a question of semantics. On the other hand, to me it doesn’t make much sense to say spending on haircuts is “a part of” income. It makes sense to say wages and capital income are both a part of income. You might say:Īnd you can make the second equation more complex by breaking consumption down into spending on clothes, haircuts, restaurant meals, etc. Actually, consumption is not a part of GDP.Ĭonsider this analogy. I used to teach my students that consumption was roughly 2/3rds of GDP. ![]()
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