GNP Deflator Research Articles

Measuring Real Value and Inflation

Abstract The most important economic measures are monetary. They have many different names, are derived in different theories and employ different formulas; yet, they all attempt to do the same thing: to separate a change in nominal value into a ‘real part’ due to the changes in quantities and an inflation due to the changes in prices. Examples are: real national product and its components, the GNP deflator, the CPI, various measures related to consumer surplus, as well as the large number of formulas for price and quantity indexes that have been proposed. The theories that have been developed to derive these measures are largely unsatisfactory. The axiomatic theory of indexes does not make clear which economic problem a particular formula can be used to solve. The economic theories are for the most part based on unrealistic assumptions. For example, the theory of the CPI is usually developed for a single consumer with homothetic preferences and then applied to a large aggregate of diverse consumers with non-homothetic preferences. In this paper I review both the general literature and my own past contributions in order to identify theories of measurement that are based on plausible economic assumptions. It turns out that all such theories lead to the Törnqvist price or quantity indexes. The paper also covers several related topics, particularly the presently unsatisfactory determination of the components of real GDP. I also propose a novel set of integrated accounts to measure changes in relative prices as well as the sectoral sources of inflation.

Measuring Real Value and Inflation

The most important economic measures are monetary. They have many different names, are derived in different theories and employ different formulas. Yet, they all attempt to do basically the same thing: to separate a change in nominal value into a 'real part' due to the changes in quantities and an inflation due to the changes of prices. Examples are: real national product and its components, the GNP deflator, the CPI, various measures related to consumer surplus, as well as the large number of formulas for price and quantity indexes that have been proposed. The theories that have been developed to derive these measures are largely unsatisfactory. The axiomatic theory of indexes does not make clear which economic problem a particular formula can be used to solve. The economic theories are for the most part based on unrealistic assumption. For example, the theory of the CPI is usually developed for a single consumer with homothetic preferences and then applied to a large aggregate of diverse consumers with non-homothetic preferences. In this paper I develop a unitary theory that can be used in all situations in which monetary measures have been used. The theory implies a uniquely optimal measure which turns out to be the Tornqvist index. I review, and partly reinterpret the derivations of this index in the literature and provide several new derivations. The paper also covers several related topics, particularly the presently unsatisfactory determination of the components of real GDP.

Measuring Real Value and Inflation

The most important economic measures are monetary. They have many different names, are derived in different theories and employ different formulas; yet, they all attempt to do the same thing: to separate a change in nominal value into a ‘real part’ due to the changes in quantities and an inflation due to the changes in prices. Examples are: real national product and its components, the GNP deflator, the CPI, various measures related to consumer surplus, as well as the large number of formulas for price and quantity indexes that have been proposed. The theories that have been developed to derive these measures are largely unsatisfactory. The axiomatic theory of indexes does not make clear which economic problem a particular formula can be used to solve. The economic theories are for the most part based on unrealistic assumptions. For example, the theory of the CPI is usually developed for a single consumer with homothetic preferences and then applied to a large aggregate of diverse consumers with non-homothetic preferences. In this paper I review both the general literature and my own past contributions in order to identify theories of measurement that are based on plausible economic assumptions. It turns out that all such theories lead to the Tornqvist price or quantity indexes. The paper also covers several related topics, particularly the presently unsatisfactory determination of the components of real GDP. I also propose a novel set of integrated accounts to measure changes in relative prices as well as the sectoral sources of inflation.

Unit Root Tests with Smooth Breaks: An Application to the Nelson-Plosser Data Set

This paper reconsiders the nature of the trends (i.e. deterministic or stochastic) in the Nelson and Plosser (1982) series, both for the original and for an extended data set. For this purpose, I employ two tests that have been recently introduced by Enders and Lee (2006) and Becker et. al. (2006), respectively. These new tests display robustness to structural breaks of unknown forms, irrespective of the date and/or location of the breaks. Both Enders and Lee (2006) and Becker et al. (2006) approximate structural changes via Flexible Fourier transforms. Applied to the original dataset, these tests confirm the hypothesis of deterministic trends in the unemployment rate and the monetary aggregates. Moreover, both tests confirm the presence of stochastic trends in nominal GNP, the GNP deflator, consumer prices, wages, velocity, bond yields, and stock prices. However, real GNP, real per capita GNP, industrial production, employment, and real wages display mixed evidence of both a stochastic and a deterministic trend, although results are more conclusive for the extended data set. For the latter, the tests deliver strong evidence in favor of a nonlinear deterministic trend for real GNP, real per capita GNP, employment, the unemployment rate, and stock prices. Further, the two tests confirm the existence of stochastic trends in nominal GNP, consumer prices, real wages, monetary aggregates, velocity, and bond yields. Additionally, this conclusion appears to be verified for the GNP deflator and nominal wages. Industrial production is the only inconclusive result. In general, it appears that real variables are stationary while nominal ones have a unit root.

Are US macroeconomic series difference stationary or trend-break stationary?

This article tests for the presence of a unit-root in all time series included in the extended Nelson–Plosser data set using the statistics devised by Zivot and Andrews, Perron and Murray and Zivot. It specifies the mixed model characterization of the trend-break stationary alternative that allows for a simultaneous break in both the intercept and slope of the trend-function. It rejects the unit-root null hypothesis for real GNP, nominal GNP, real per capita GNP, industrial production, employment, GNP deflator, nominal wages, interest rate and common stock prices. Use of appropriate critical values to assess the significance of the trend-function coefficients reveals that the slope-break should be included in real GNP, nominal GNP, real per capita GNP, nominal wages, interest rate and common stock prices. The results indicate that there is less evidence against the unit-root hypothesis with the extended Nelson–Plosser data compared to the original Nelson–Plosser data.

Modeling the Demand for M3 in the Unified Germany

An error correction model for the demand for real M3 money is constructed for the period of 1976–1994 with real GNP, the GNP deflator, as well as a short-term and a long-term interest rate as explanatory variables. Quarterly, seasonally unadjusted data are used in estimating the model. It is found that there is a clear structural break due to the German unification in 1990. On the other hand, once this structural break is accounted for, a stable relation is found which resists a series of specification tests. These include a number of recent tests of parameter constancy and linearity. Our specification is at variance with findings reported by some other researchers, notably the Deutsche Bundesbank.

Unit Root Analyses of the Causality Between Japanese Money and Income

Unit root techniques and cointegration analysis have developed considerably in the last ten years. At the same time, the nonstationary test for Granger causality has been developed. We shed some new light on Japanese money supply and income causality by using nonstationary techniques. We specify univariate ARMA models of money, income, GNP deflator and rate of interest, initially by using the Dickey and Fuller (DF) or the augmented DF (ADF) tests. Two diagnostic tests are applied to each selected ARMA regression. One is the residual DF test, and the other is the moving average (MA) unit root test of residuals. After selecting the ARMA model, some causality tests are applied to the error correction model (ECM) of a vector autoregression (VAR) one of which is ordinary least squares (OLS) and another is the maximum likelihood (ML) method. The former requires only the standard F-test on the deleted variables in the ECM. The latter requires the Johansen’s ML method in estimating cointegration. Causality is found to go from income to money supply but not the other way. Appendices include a simple implementation of the MA unit root test, a pedagogical proof of the Granger causality tests developed by Toda and Phillips (1993) and an interpretation of the test proposed by Toda and Yamamoto (1995). KEYWORDS: causality, non-stationarity, money, income, cointegration. JEL Classification Numbers: C32, E50.

Testing the unit root with drift hypothesis against nonlinear trend stationarity, with an application to the US price level and interest rate

This paper is concerned with testing the unit root with drift hypothesis against a very general trend stationarity hypothesis, namely the alternative that the time series is stationary about an almost arbitrary deterministic function of time. Our approach employs the fact that any function of time can be approximated arbitrarily close by a linear function of Chebishev polynomials. We propose various tests on the basis of an Augmented Dickey-Fuller auxiliary regression with linear and nonlinear deterministic trends, where the nonlinear deterministic trend is approximated by detrended Chebishev time polynomials. Also, we propose a model-free test. We apply our tests to the GNP deflator, the consumer price index, and the interest rate for the USA, taken from the extended Nelson-Plosser data set. The results indicate that these series are nonlinear trend stationary.

Modelling the growth of American aggregates based on the metalogistic time function

A relatively simple function derived from Benouilli’s differential equation and given the class name “metalogistic” is shown to be an efficient descriptor of the dynamics of a number of important American aggregates. These include five demographic, i.e. population, urbanization, immigration, birth‐rate, and death‐rate over the 1820‐1992 time period; and six socio‐economic, that is gross national product, GNP deflator, civilian labour force, unemployment, total energy in BTU, and a surrogate of higher knowledge, these over the 1880‐1992 time period. The descriptor in each case is defined by parameters derived from the data through regression, with model efficacy measured by anR2> 0.90 in almost all cases.

An analysis of RSQE forecasts: 1971–1992

The purpose of this paper is to evaluate the accuracy of ex ante econometric model forecasts of four key macroeconomic variables: real GNP growth, the rate of price inflation measured by the GNP deflator, the civilian unemployment rate, and the Treasury Bill rate. Annual forecasts produced by the Research Seminar in Quantitative Economics (RSQE) based on the Michigan Quarterly Econometric Model of the U.S. Economy are compared with quasi ex ante forecasts from a four-variable vector autoregressive (VAR) model. Statistical tests of the equality of forecast error variances as well as univariate and multivariate forecast encompassing-type tests are conducted. The forecast error variance comparisons indicate that for three of the four variables the RSQE forecasts are more accurate than the VAR forecasts and for one of the variables (real GNP growth) only slightly less accurate. The forecast encompassing-type tests indicate that the RSQE forecasts contain information not contained in the VAR forecasts and, conversely, that VAR forecasts contain information not included in the RSQE forecasts. The scope for improving RSQE forecasts by combining them with VAR forecasts is rather limited, however.

Do we need a price index for industrial R&D?

Price deflators for research expenditures of 12 individual industries and of all U.S. industries combined are constructed for the period 1969–1988. These indexes are derived with a set of proxy price series that are highly correlated with surveyed R&D input prices, and that may be easily extended forward in time as the requisite proxy data become available. The approach could be replicated for other countries. Given the recent consideration to treat R&D as part of capital formation in satellite accounts to the international System of National Accounts and the U.S. National Income and Product Accounts, there is an immediate need for such deflators. Trends in U.S. industrial R&D expenditures utilizing these R&D deflators, and others found in the literature, are contrasted. Although broad-based deflators — such as the GNP deflator used in reporting most official R&D statistics provide reasonable approximations of changes in aggregate industry R&D costs, they are much less appropriate for calculating real R&D expenditures of individual industries. The industry-specific R&D indexes built here rather readily capture variations in inter-industry R&D cost trends that broader deflators miss.

Une étude empirique des sources des fluctuations économiques dans le cadre d'un modèle à tendances communes

The estimation of common trends models allows us to shed light on the debate about the source of economic fluctuations in four OECD countries. As one cointegrating relation is found between the real GNP, the government expenditures, the monetary aggregate M1 and the real GNP deflator, three common trends are identified. The supply permanent shock accounts for a large part of business cycle variations of the four variables. However, the innovations in the demand stochastic trends appear highly significant in explaining the short run fluctuations of the real GNP and have persistent effects on its level.

Shifting trends, segmented trends, and infrequent permanent shocks

A stochastic trend model is considered in which permanent shocks occur infrequently and randomly. We show that this model is observationally equivalent to shifting/segmented deterministic trend models. Moreover, we show that standard, full-sample time series methods are incapable of distinguishing between small, frequent permanent shocks and large, infrequent permanent shocks. An outlier search, however, reveals substantial evidence of large, infrequent shocks to the GNP deflator and that these shocks account for most of the persistence in the GNP deflator. For real GNP, evidence of infrequent permanent shocks is weaker.

Terms of trade, CPI, GNP deflator, and economic welfare

We can judge whether a given terms of trade change increases or decreases the economic welfare of a small, open country, correctly, under the unchanged production possibility frontier, by comparing the true CPI with the true GNP deflator. Also we can do so correctly by comparing the fixed-weight price index (like the Laspeyres or Paasche) for consumption with that for production except for cases of unrealistic and rare anomalies. In and only in the anomalies, the change in the fixed-weight terms of trade is inconsistent with that in the true one. J. Japan. Int. Econ. , March 1991, 5 (1), pp. 60–85. Institute of Socio-Economic Planning, University of Tsukuba, Tsukuba, Ibaraki 305, Japan.

Price Indexes for Deflating Public Forestry Research Expenditures

Abstract The extent to which inflation has eroded the real purchasing power of forestry research budgets is poorly understood. No widely accepted and satisfactory price index exists for assessing the impact of inflation on forestry research. Official government research statistics use the GNP deflator to express research expenditures in constant dollars, despite the serious shortcomings of such a broad indicator of inflation for deflating research expenditures. Two forestry research price indexes are calculated in this paper, one for USDA Forest Service research and the other for university forestry research. The GNP deflator has adequately represented the inflationary trend in Forest Service research, but it has substantially underestimated the rate of inflation in university forestry research in recent years due mainly to real growth in faculty compensation during the 1980s. The divergence between the university forestry research price index calculated in this study and the GNP deflator indicates that the purchasing power of university forestry research is significantly less than estimates based on the GNP deflator would suggest. For. Sci. 35(3):756-774.

The Estimation of Prewar Gross National Product: Methodology and New Evidence

The paper develops new methodology for the estimation of prewar GNP, taps previously unused data sources, and develops new estimates for the periods 1869-1908 and 1869-1928. Primary among the new data sources are direct measures of output in the transportation, communications, and construction sectors and estimates of the consumer price index. New measures of real GNP, nominal GNP, and the GNP deflator are developed. The new estimates of real GNP are as volatile on average over the business cycle as the traditional Kuznets-Kendrick series but dampen the amplitude of some cycles while raising the amplitude of others. The new estimates of the GNP deflator are distinctly less volatile than the traditional series and in fact no more volatile than those in the postwar period.

Reply to Cosimano and Jansen

First impressions to the contrary, the results obtained by Cosimano and Jansen are remarkably similar to those I reported in 1983. We agree that there was little increase in the variance of inflation in the seventies but a very high variance in the late forties and early fifties. And we agree that the level and variance of inflation do not appear to be systematically related. The points of difference are more methodological and it is here that their paper is most misleading. They claim that my model was misspecified in several fashions. There was serial correlation in some residuals the sample period was incorrect, and the lags were not sufficiently long. However, to make such claims, they must take my model as the null hypothesis and test against it. This is the way all diagnostic tests are constructed and is the general thrust of scientific inquiry. In contrast, they only show that in models superficially similar to mine, there is serial correlation. For example, they estimate my model without the ARCH correction and then find serial correlation for one of the three dependent variables. Had they estimated the model with the heteroskedasticity corrected, the residuals divided by their standard errors should no longer have displayed the serial correlation. In effect, by weighting all data points equally, they give too much weight to the volatile period which has little serial correlation, leaving some serial correlation in the OLS residuals. Furthermore, the test for serial correlation, Godfrey's LM test, only has the correct size under the null that the model is correctly specified in both mean and variance. Thus the admission that there is ARCH invalidates the test based on least squares. The solution proposed by the authors is to throw out the troublesome part of the sample period. This is accompanied by an observation that it coincides with one of the improvements in the CPI statistics (even though the problem shows up in the GNP deflator but not the CPI or PPI equations), and some tests for parameter constancy which allow for a constant variance or one which changes at the split point. (The procedure used for the latter test is not described.) In no case however is there evidence presented directly against the ARCH model. For example, dummy variables for the split could be introduced into my ARCH model either additively or multiplicatively and tested with tor F-tests. In fact, the

Sources of Economic Fluctuations in the United States

There has been much recent discussion about the ultimate sources of macroeconomic variability. A number of authors attribute most of this variability to only a few sources, sometimes only one. Although there may be only a few important sources, this is far from obvious, since economies seem complicated. The purpose of this paper is to provide quantitative estimates of various sources of variability using a U. S. econometric model. Stochastic simulation is used to estimate how much the overall variances of real GNP and the GNP deflator are reduced when various shocks are suppressed in the model.

On the causes of the rise in the liquidity ratio in The Netherlands during the early eighties

During the early eighties the liquidity ratio in The Netherlands shows a sharp rise. The aim of this article is to inquire into the causes of this rise. This has been done by means of the demand theory of money. The analysis leads to the following conclusions. (1) An aggregate analysis of money demand does not seem appropriate. (2) Disaggregation of money demand into household and business demand yields more satisfactory results: (a) money demand by business depends on the real value added of the business sector, the GNP deflator and labour's share in the value added of the business sector; (b) money demand by households depends on real gross national product, the GNP deflator and the capital market interest rate. (3) The rise in the early eighties is essentially due to the increase in the money holdings of the business sector, which in turn is mainly caused by the increase in profitability.

Bias in systems of survey and econometric forecasts

Many studies in recent years have found survey and econometric forecasts to be significantly biased. Typically, this bias has been measured by individual estimation of Theil's U-statistic or ordinary least squares (OLS). The purpose of this paper is to estimate jointly, rather than individually, the bias in survey and econometric forecasts. Specifically, the biases in forecasts of U.S. nominal and real GNP, the GNP deflator, and the unemployment rate are estimated simultaneously by means of Zellner's Seemingly Unrelated Regression procedure. The results from this generalized least squares (GLS) method differ considerably from the OLS results. Specifically, the GLS findings (contrary to the OLS results of this and other studies) indicate that econometric model forecasts are, in general, not significantly biased. The Zellner procedure does find, however, significant bias in the ASA/NBER survey forecasts.