Thread by @BachmannRudi

Lecture 3 of Intermediate Macroeconomics:

Today we discovered a potential problem with nominal GDP computation: the yardstick is prices and these prices may not exist (government revenue), may be "bad" ( e.g., monopoly) prices, or may change over time.

In particular, the latter effect potentially obfuscates nominal GDP increases between two time periods because we don't know whether the actual pie increased or simply the yardstick, the prices, changed.

I showed you an imperfect remedy to this problem by fixing a base-year price system that allows us to compute real GDP relative to a base year (using the price system from that base year).

Once we have nominal and real GDP we can also compute an implied deflator, something like the general price level in the economy. From this we can compute a first measure of inflation: the percentage change in the GDP deflator.

This is not, however, the headline inflation number that the business press publishes. They use the CPI concept, where we fix a consumption basket and track the development of the cost of this basket over time. Inflation is then defined as the percentage change in the CPI.

In the U.S., it's typically the CPI for all urban consumer that is reported. A comparison between deflator-based inflation and CPI-based inflation reveals (1) that they track each other decently well, but (2) that, in times of energy price hikes, CPI-inflation will move more

strongly than deflator-inflation. In general, because the CPI is based on a different (more narrow) set of goods than the GDP deflator, inflation based on the former tends to be more volatile than inflation based on the latter.

The important message is: there is no such thing as THE inflation rate. We also have produce price indices (PPI). You need to always interpret inflation numbers carefully.

We then mentioned the four canonical biases that lead to overestimation of inflation: substitution bias, outlet bias, quality bias, and new goods bias. That is why the FED interprets its price stability mandate as 2% measured inflation.

We concluded the lecture by introducing the concepts of GNP, net factor payments (NFP), saving (careful: saving in macro is a flow concept (per period of time), not a stock concept (at a point in time), like wealth).

Next week, we will see macroeconomic data in practice.

Producer price indices ...

Lol.