Oh NGDP, is there anything you can't do?
In a long post over at Free Exchange, Ryan Avent passionately defends the honor of NGDPism against any and all heretics. This time it's GMU wonder boy Eli Dourado in the cross-hairs.
But Mr. Avent's analysis, to speak plainly, makes no sense at all. Let's break it down.
Mr. Avent starts with this chart, which he argues shows how NGDP growth is strongly related to job growth and thus crucial to economic performance:
But people here's the thing. NGDP is PY, the price level times real income. And one of those components, real income, is indeed highly correlated with jobs. The other component, prices, is not.
Let's look at how inflation (growth in the price level) and real GDP growth each chart up with jobs growth over Mr. Avent's sample period, starting with inflation:
The linear correlation between inflation and jobs growth shown here is 0.22, which is INSIGNIFICANTLY DIFFERENT FROM ZERO (t-stat = 1.01). In other words, one component of NGDP, prices, is not significantly correlated with job growth over this period (not even at the 0.20 level). Another way to see the lack of correlation is to note that if we ran a regression of jobs growth on inflation here the r-square would be around 0.05.
Now let's look at the other component, Real GDP growth:
The linear correlation between real GDP growth and jobs growth shown here is 0.64 which is SIGNIFICANTLY DIFFERENT FROM ZERO (t-stat = 8.2) at the 0.01 level. The r-square of this regression would be around 0.41.
In other words, Mr. Avent is using fluctuations in the real economy to explain fluctuations in the real economy. When real output tanks, jobs tank. It does appear from the graph that GDP growth might lead job growth, but we are really just graphing the same thing twice here.
People there's plenty more to come after the jump:
Mr. Avent then doubles down and says the close relationship between NGDP growth and jobs growth doesn't always hold, and shows another chart from a period where NGDP growth was "too high":
Mr. Avent considers this 1960-1980 period to be a different world than the more recent period discussed above.
But, you know what people? It's actually exactly the same world, and that is a world where Mr. Avent is wrong.
Let's go to the breakdown:
Here's the inflation - job growth graph for the period Avent chose:
Here the linear correlation between inflation and jobs growth is negative -0.15, but it's still NOT SIGNIFICANTLY DIFFERENT FROM ZERO, just like in the more recent period Mr. Avent initially used. The r-squared of a regression would be just about 0.02.
Now the Real GDP growth - job growth graph:
The linear correlation between real GDP growth and job growth here is 0.66, virtually indistinguishable from the 0.64 correlation in the first time period, and significantly different from zero at the 0.01 level.
Both periods Mr. Avent uses are periods where job growth is uncorrelated with inflation and very highly correlated with real GDP growth. It's only the misguided insistence of the NGDPist in treating these two very different things equally that fools Mr. Avent into seeing two different worlds.
In sum, Mr. Avent's charts and post are simply nonsense.
There are two major problems here.
The first is that using real growth to explain job growth, and make no mistake, Mr. Avent is doing exactly that, is like explaining Y with Y. They are two measurements of the same concept; the overall level of economic activity. One is not explaining the other, they are moving together expressing the same overall economic concept.
The second, and overall more troubling problem, is this strange tenet of NGDPism, that one shouldn't separate nominal income growth into real growth and inflation, that NGDP fluctuations somehow have the same effect on the economy whether they come from inflation or real growth. That is just an elementary economic error that the NGDPers are somehow trying to turn into a theorem!
Think about it like this. Your boss tells you that NGDP is surging and wants to know if it will be profitable to hire more workers and expand the business. To give a good answer, as I've just illustrated, you absolutely want to know WHICH COMPONENT, P or Y is surging. If you just go by the NGDP aggregate, you are really hurting your chances of keeping your job.
Another way to say this is that there are many ways to achieve any rate of NGDP growth. But not all of them are equally desirable. Say we want 7% NGDP growth. Are we really indifferent between 2% real GDP growth and 5% inflation vs. 5% real GDP growth and 2% inflation (yes I know I'm taking a minor math liberty in these examples)?