Inflation and GDP growth

Interesting chart from the WSJ on inflation measurement.

Also, a post from The Big Picture on how this will impact GDP growth in the current quarter:

At 8:30am, we get the advance GDP data from BEA. Consensus is for a marginally positive data point -- 0.3%. This will follow Q7 2007 of 0.6%.

In terms of debunking the misleading data stats, today is the day where the rubber meets the road. Why? Well, if the official inflation data was reported in a way that was more reflective of reality, Q4 last year would likely have been anywhere from 0.75% to 1.5% lower (if not more), sending it into negative territory.

The same will be true for today's GD data point, with the probable overstatement enough to keep it marginally positive or flat.

Why does inflation matter so much to GDP? Gross Domestic Product (GDP) is the "broadest measure of aggregate economic activity and encompasses every sector of the economy." If you want to know understand how weak or strong an economy is, GDP is where you begin. But, you need to determine how much of GDP is nominal, and how much is real (i.e., after inflation growth).

Consider an economy that sold $100 worth of goods and services in one quarter. The next Q, it produced $110 worth. When determining the GDP of this economy, you want to know how much of those gains was additional output, and how much merely price increases. Its usually a combination of more widgets and higher prices, so if you want to know exactly how much the economy expanded, you need to know exactly how much inflation there was. Understate inflation, and you overstate growth.

If today's GDP is marginally positive, following Q4's marginally positive GDP data, then we officially will not be in a recession by the classic "2 consecutive quarters of negative GDP growth." This means that if the correct inflation deflator was built into GDP, we would have our two consec quarters.

Hence, for the reality based community, the recession will be officially here.

Of course, if you believe that actual inflation is running about 2.5%, then you should feel free to ignore this analysis.

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