Arnold Kling  

Nominal GDP and Employment

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The ratio of nominal GDP to employment is NGDP/L, where L is the level of employment. This can be decomposed into:

NGDP/L = (NGDP/RGDP) x (RGDP/L) = the GDP deflator x productivity

As long as inflation and productivity growth are close to trend, or as long as the product of the two is close to trend, the relationship between nominal GDP and employment will be close to trend.

This leads me to expect to find that when nominal GDP growth is low, employment growth is also low. You would only not get that if there were a big surge in inflation and/or a big surge in productivity.

The way I look at it, this means that the relationship between nominal GDP and employment has almost no theoretical import. In particular, it does not constitute evidence in favor of the AS-AD paradigm. The AS-AD story, as Scott Sumner tells it (and pretty much any mainstream macro would say the same thing), is that changes in nominal GDP cause changes in employment, rather than the other way around.

The PSST story is equally consistent with a correlation between employment and nominal GDP. It just interprets the causality as running the other way. If a bunch of workers are laid off, for whatever reason, nominal GDP will go down, unless productivity and/or inflation rise in order to compensate.

Defining aggregate demand as nominal GDP finesses such difficult issues as defining the money supply or justifying specific parameters of a macroeconomic model. But there is a priced to be paid. And that price is vacuousness.


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CATEGORIES: Macroeconomics



COMMENTS (5 to date)
Steven writes:

As Scott Sumner will no doubt tell you in great detail, you're misstating the mainstream AS-AD position. Increases in NGDP will increase employment if the SRAS curve is flat, and not otherwise.

david writes:

The PSST story is equally consistent with a correlation between employment and nominal GDP. It just interprets the causality as running the other way. If a bunch of workers are laid off, for whatever reason, nominal GDP will go down, unless productivity and/or inflation rise in order to compensate.

... wait, what? Unless inflation rises in order to compensate? What happened to the notion of 'PSST laid-off workers cannot be rehired'?

Arnold,

Even if this was correct in terms of historical interpretation of data within a particular economy (which it might well be), I think it would still be the case that A) you can make a non-vacuous conditional claim that if the central bank did as Scott and others would like, we wouldn't have these periodic bouts of mass unemployment that PSST is supposed to explain, and B) you can do cross-country comparisons (e.g. Scott's post from a while ago about how there don't seem to be any PSST problems in Sweden or Poland, seem to also remember Matt Yglesias on divergence between Denmark and Finland but can't find the link) which somewhat tests this claim, insofar as a lot of the biggest PSST issues should hit both at the same time (e.g. the impact of the internet / outsourcing to countries with cheap labour).

I'd also add that in some ways the causality is even harder to disentangle, because an NGDP-led recession should cause PSST issues due to income effects. It seems to me that PSST-type unemployment almost certainly happens, it's just a question of what fraction of unemployment it explains. Cross-country comparisons are (I think) our best bet for getting a feel for that.

kio writes:

1. Labor force, L, includes employment, E, and unemployment, U. The rate of employment E/P, where P is the working age population is a function of real GDP per capita (http://mechonomic.blogspot.com/2011/07/when-rate-of-unemployment-will-fall-to.html) . Same is valid for the rate of unemployment (Okun's law) - http://mechonomic.blogspot.com/2011/07/okuns-law-revisited-is-there-structural.html

2. Since the rate of employment is defined by GDP, labor productivity is a secondary macrovariable totally depending on GDP itself -http://mechonomic.blogspot.com/2010/12/labor-productivity-in-canada.html

3. Inflation is defined by the change in labor force (i.e in the rate of participation and the growth in working age popualtion). Price infaltion may lag behind the change in labor force (http://mechonomic.blogspot.com/2011/01/did-we-predict-well-2010-inflation-in.html)

4. All in all, NGDP is a lagged function of GDP and the change in working age population. Thus, it may be well correlated with E or with L.

There is an article in JAES on the empirics of these links (http://ideas.repec.org/a/ush/jaessh/v3y2008i4(6)_winter200839.html)

and a separate article on labor force/GDP link in developed countries - http://ideas.repec.org/a/ush/jaessh/v3y2008i3(5)_fall2008p203-222.html

Scott Sumner writes:

Arnold, You said;

"This leads me to expect to find that when nominal GDP growth is low, employment growth is also low. You would only not get that if there were a big surge in inflation and/or a big surge in productivity."

Maybe I'm having a brain freeze, but is this backward? The standard view is that if NGDP is low, you are actually better off (in terms of RGDP) having a falling price level.

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