Arnold Kling  

Scott Sumner, for the Myth of the Macroeconomy File

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He writes,

There are no solid theoretical foundations for price level theory in a modern economy where hedonics is very important. It's not just that we're not good at measuring price changes for computers and consulting services; it's not even clear what we are trying to measure in theory. Is "a computer" something that yields constant utility? If so, then we need to figure out what utility is. If it's happiness, and if that's the theoretical foundation for price level theory, then it means the inflation rate measures the wage increase required to preserve the current level of happiness. In that case, if surveys show people aren't getting any happier over the decades, then that means RGDP/person is constant. But that's nonsense. How can inflation be the "theoretically" appropriate variable for these models, if there's no obvious way to partition computers into prices and output? The only objective fact is the revenue Dell earns from selling computers; the "quantity" is purely arbitrary.

...I'm inclined to argue that average hourly wages are the only reasonably objective nominal aggregate that measures a sort of "inflation" (albeit input price inflation.)

I think there is something to be said for doing a Cartesian meditation on macroeconomics. Descartes asked himself what he could still believe if he distrusted all of the information from his senses. That is how he ended up with "I think, therefore I am."

I am not saying to distrust everything, but we should worry, for example, that the distinction between nominal and real GDP growth is so heavily influenced by price changes, which in turn require quality adjustment. Presumably, quality change in labor input is slow. That would make wage changes a better indicator of price changes.

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CATEGORIES: Macroeconomics

COMMENTS (5 to date)
Becky Hargrove writes:

For a good part of the twentieth century, we were somewhat fooled by wages as well, as they represented what developed economic systems were able to send out into the world, beyond themselves. All the numbers became skewed when the places those goods got sent to, became their own fully functioning, economic systems.

Now, as developed systems look at one another as parts of a whole, they are forced to consider how to create circles of economic sustainability. That changes everything about how wages might be arrived at. It's as if a group of people were sitting around in a room and saying, how can we create a money system that allows money to flow between all of us? Is it even possible for people to have similar or equitable wages in such a reality, or is there more involved.

Thomas DeMeo writes:

I would think that we would badly underestimate price changes by looking at wages.

andy writes:

Reminds me of a counter-example to 'deflation is bad' - computer industry. Clever answer is: you cannot say deflation is bad, because computer industry is just one sector, not 'economy as a whole'; second, this industry is experiencing huge productivity increases, that's an exception.

P=weighted average of produced goods; if price of computers gets 50% down and we assume elasticity is 1, higher productivity in IT does mean deflation; this is a clear counter-example to 'deflation is bad' argument. On the other hand, if the falling prices are caused by productivity increases, than you will experience global 'deflation', while when looking on a per-industry basis you will see it exactly in the productive industries.

But there is more; let's suppose somebody had a clever idea regarding production of gadgets that saves 50% material; everybody incorporated such idea (with zero cost); for simplicity assume elasticity 1. What changed for the consumers? They buy twice as many 'gadgets' than before; we should definitely consider this an improvement when we measure welfare. What changed for the financial sector? Nothing. Should central banks consider this as 'deflation'? Absolutely nothing changed in the economy to warrant it.

It seems to me that welfare measuring and 'inflation measuring' for monetary purposes are quite different things. If you want to target something, NGDP targetting might be a better idea.

Becky Hargrove writes:

The reason it is hard for me to take prices seriously in the moment: what industry does the product exist in? Someone (often the taxpayer) pays at least $50 for a container of diabetic test strips that may last a few weeks. They consist of a tiny piece of plastic with a simple electronic included. How many items at the dollar store are more complex and yet a fraction of that price?

kyle8 writes:

In my view the only comparisons that make sense is to compare average hour worked to purchase everyday items over time.

For instance, How many hours at average wage were needed to work in 1970 to purchase a loaf of bread, a minimum prices automobile, or something else that is considered a staple of the average life.

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