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December 5, 2008
Does GDP tell us how we are doing?
Recently, we held a Fed Challenge orientation here at the Fed. Students were encouraged to memorize “C+I+G+NX” -- even being promised by an instructor that this knowledge will impress on Friday night. We may have oversold, but the point is that GDP is often how we begin a conversation about monetary policy goals. We talk about it as a way to measure how our economy and ostensibly how we are doing.
A student from the orientation, Kevin, asked a great follow-up question: Why do we use GDP instead of something like the Genuine Progress Indicator (GPI)? GPI adjusts GDP downward for things like the cost of crime fighting, pollution costs, changes in leisure time, dependence on foreign assets, etc. Kevin’s underlying point is a good one. Aren’t we after all looking to see how we are doing as a society -- so if crime goes up and we are spending more on police services, we should not see that as progress even though GDP goes up.
A similar welfare indicator that is well known is the Human Development Index (HDI), a composite index published by the United Nations. This index takes into account factors like literacy levels, education levels, GDP per capita, distribution of income, access to clean water, and quality healthcare. The US ranks 12th in HDI and 2nd in GDP per capita. This disparity points to the problem Kevin raised in using GDP as a measure of welfare.
In my opinion, these welfare indices are great assets to policy makers as they give valuable data on thematic areas (literacy, education, empowerment). However, they are composite indices which mean that they collect data from many sources, leading to many accuracy issues. The HDI website strongly suggests that the composite data not be used to create trend analysis. However, these accuracy issues should not render the data worthless. After all, we should be asking ourselves why the US’s income inequality ratio is high (Gini coefficient – included in HDI). A better (more equal income distribution) Gini coefficient is usually correlated to higher per capita GDP, but the US seems to be one of just a handful of exceptions.
With this said, the Fed probably won’t get away from focusing on GDP, although limited, it is something that is easier to accurately measure and responsive to policy changes in a relatively short amount of time (months). Welfare indices, like the ones above, may be good long-term measures, but perhaps difficult to use in the Fed’s capacity as they tend to change very slowly. Just think how long it takes pollution and literacy changes to be reflected.
But the conversation does beg the question – should the Fed/policy makers use them at some level? At the very least, focus more on GDP per capita? What do you think?
Posted by Cindy at December 5, 2008 11:05 PM
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GDP does not account for productivity gains and many other variables. Oliver Blanchard estimates that GDP understates growth by .6% per year. Robert Solow said that technology shows up every where but in the statistics since people use new technology in old ways. I believe that the error in measurement has been constant since the 1970's and not increasing, so why change it?
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