Saturday, September 29, 2012

Moving the goalposts in the NDGP debate, or money illusion illusion

Matt Ygelias reacts to my showing that inflation is uncorrelated with jobs growth while real GDP growth is highly correlated with jobs growth by deftly moving the goalposts:

Hiring workers is probably the wrong thing to think about. Let's worry about hiring capital goods. Some extra space for your business or some extra production equipment. You know the price of said capital and you know roughly what it does, but you're not sure whether you should buy it or not. You look to your left and you see a stack of dollars. You look to your right and you see a bunch of machines. Do you want to trade the dollars for the machines? It's a close call.

Now a little birdie from the Bureau of Labor Statistics shows up and tells you that the price level is going to surge over the next three years. Suddenly your decision is made for you. That stack of dollars isn't as valuable as you thought it was. Buy the machines!

So now the claim is that we don't need to separate NGDP (PY) growth into inflation and real growth because inflation changes investment decision.

Let's go to the charts, people. I am sticking with the two time periods Ryan Avent chose in the post that started all this in order to not be open to the charge of cherry picking dates.

So from 1990 to the present, here's the graph of real investment growth and inflation:


The linear correlation beween the two series is -0.007. Yikes!

Now for real investment growth and real GDP growth over the period:


The linear correlation between these two series is 0.78.

Inflation is uncorrelated with real investment growth, real growth is highly correlated with real investment growth.

Now let's look at the other Avent period, 1960 - 1980 starting with inflation and real investment growth:


The linear correlation here is -0.174.

Now for real investment growth and real GDP growth:



The linear correlation between these two series is 0.83.

So in practice inflation is uncorrelated with real investment growth, while real GDP growth is incredibly highly correlated with real investment growth.

So it seems, yet again, that business decision makers DO distinguish between which component of NGDP are changing, and if it's the P component, they ignore it when making decisions about changing employment and changing investment.

The US economy in these time periods at least, was not caught in the grip of money illusion.






6 comments:

Joshua Wojnilower said...

Matt's model appears to assume that machines are the only good in the economy. Therefore, a rise in the price level means a rise in the price of machines relative to money (so obviously you buy machines).
Instead, let's assume that the economy has food, oil and housing, too (which account for a decent portion of inflation). Now, if those prices rise along with the price level, then demand for goods produced by machines may actually decreases. It's even possible that the price of machines will decrease.
In a world with heterogeneous goods and capital, even knowing the general price level will rise, is not sufficient knowledge to know the relative price of goods. This may help explain why investment is uncorrelated with inflation.

We may be in the minority fighting against NGDP/Market Monetarism but it's clearly a debate worth the effort. Keep up the good work!

Pedro said...

Correlation between NGDP and real non-residential investment (growth) = 0.87.

Angus said...

LOLZ Pedro. Good one! 8^) LOLZ

Peddro said...

Correlation between NGDP and total private job openings (quarterly, % change over year) is 0.76. (2002 to 2012).

Angus said...

Vote for Peddro!

TGGP said...

David Glasner points out that inflation is not normally correlated with the S&P 500, but recently it has been.