I made an updated version of this post with 2007 GDP statistics. I also use gold as an index of inflation, in addition to M2.

The commonly published GDP statistics say that GDP is increasing, after adjusting for inflation.

Adjusting for inflation using the CPI is wrong. The CPI understates the true inflation rate. In a previous post, I showed the median household income is DECREASING if you correct for inflation using money supply expansion instead of the CPI.

What about GDP? Does that share the same defect? I use the Federal Reserve's official M2 report, along with this source for GDP unadjusted for inflation. I also looked at the official US government GDP statistics, but the former site looked better and the numbers were close anyway.

I am using the "GDP not adjusted for inflation" statistic.

The GDP was $12433.9 billion in 2005 and $13194.7 in 2006, for a growth rate of 6.119%. M2 was $6408.4 trillion in January 2005 and $6705.8 trillion in January 2006, for a growth in M2 of 4.64%. However, the number of households increased from 113,343 thousand to 114,384 thousand from 2004 to 2005, for a gain of 0.92%. (The housing stats table doesn't have an entry for 2006, so I used 2004-2005 instead of 2005-2006.) This leads to a growth in GDP of about 1.48% in absolute terms, only 0.56% in real terms. This is much lower than the official GDP growth rates.

I correct for the number of households, because with 0.92% more households, you would expect the GDP to increase by 0.92% if every new worker has the same level of efficiency.

If you use M3 instead of M2 as your index of inflation, you would find that real GDP actually was decreasing! The rate of growth in M3 is 10% more than M2, so if you use M3, the US economy is shrinking at a rate of 10% per year!

Let's look at a longer time period. GDP was $5484.4 billion in 1990 and $13194.7 in 2006, for a GDP growth rate of 140.6%. M2 was $3176.6 trillion in January 1990 and $6705.8 trillion in January 2006, for a growth in M2 of 111.1%. In other words, the actual GDP growth rate from 1990 to 2006 was only 29.5%, an annualized rate of 1%. This is a far cry short of the official government statistics.

I still haven't corrected for the increase in the number of households. In 1989, there were 93,347 thousand households, and there were 114,384 thousand households in 2005. That is a gain of 22.5%. If you subtract 22.5% from 29.5%, you get 7%. (The housing stats table doesn't have an entry for 2006, so I used 1989-2005 instead of 1990-2006.)

Contrary to official reports, GDP has only increased by 7% per household from 1990 to 2006. That is an annualized real GDP growth rate of only 0.27%.

If you use M3 instead of M2, you would find that GDP has decreased substantially since 1990. Luckily, the Federal Reserve ceased publishing M3!

I used GDP in this post. If you repeat the calculation with GNP, you probably would find nearly the same result. I'll only perform that calculation if someone asks.

If you calculate inflation-adjusted GDP growth using M2 money supply expansion instead of the CPI, and correct for the increase in the number of households, you find that per-househould GDP has barely increased since 1990. If you use M3 instead of M2, you would find that GDP has substantially decreased!

## 7 comments:

What sense does it make to use money supply as an index for inflation? None I think. It seems natural and sensible for money supply to increase roughly proportionally to GDP. Therefore by deflating GDP growth by money supply growth it would be expected to get a result of approximately zero.

I think you made a mistake in the second sentence of the the fifth paragraph. You say, "M2 was $6408.4 trillion in January 2005..." However the link you give shows a January 2005 amount of 6410.9 (NOT SEASONALLY ADJUSTED) I am not quibbling with the slight discrepancy between 6410.9 and 6408.4. The link you give says,

TABLE 1

MONEY STOCK MEASURES

BILLIONS OF DOLLARS

The way you have expressed it makes the money supply seem to be 6.4 quadrillion dollars.

I really enjoy the blog and your insights.

Not really a comment about GDP growth; but about statements on the economy. The economy is good... what does that mean exactly. Well, if the top 1% owns as much as the bottom 90% and the next 9% owns as much as the bottom 90% that means that if the investments of the top 10% go up 20% and the bottom 90% drops 35% over the same time span, you have an economy that is doing well

Interestingly, I was reading a report by The Economist recently (published in 2007) saying that since 1970 productivity has gone up by 85% but real wages have only gone up by 2%... which is kind of related to what darrell commented - growth can be great (as an aggregate) but you'll still get haves and have nots. The average joe has made lots more money - just not for himself!

How can you just subtract the % of household growth from the % of GDP growth? There are way too many assumptions there and zero mathematical rigor.

The idea of considering the size of the money supply as a part of the measure of inflation sounds good though. However, basing it solely on this isn't too useful. The point of measuring inflation is to see what we feel in our pocketbooks when we engage in economic activity. That's why measuring prices is a good way to get at it.

Rather than concentrating on the growth of the money supply, it would be better to concentrate on the stagnation of wages, as that's where much buying power is lost.

It would be interesting to look at economic growth versus increasing deficits.... I believe government deficit spending has been propping up growth since Reagan... really interesting to take out social security surpluses out of the overall deficit picture and see what happens.

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