In keeping with the nominal GDP theme that I’ve had going at the moment, here’s a little data that has a coupe of intriguing artifacts. Both of the figures below are plots of the log of nominal GDP for the UK (so that we can interpret the gradient of the curve as the growth rate of nominal GDP) over different time frames.
Firstly, taking a longer view, let’s have a look at figure 1. As you can see I’ve highlighted the two points that caught my eye. At the point highlighted by the green arrow, corresponding to approximately 1937 , there is a very clear structural break, where the average growth rate seems to permanently increase. The specific timing of the increase in growth is in all likelihood a combination of the fading out of the Depression and mobilization for war. However, as you can see, there isn’t a mere temporary increase in nominal GDP growth. Rather, the increase in the growth rate is something that carries through all the way to the decline of 2008.
This shows just how important the move towards a more active demand management macro policy – and away from a completely hands off classical approach – has benefited the United Kingdom. Of course demand management policy wasn’t a unilateral success – we obviously made mistakes when it came to the original miss-specification of the Phillips Curve which led to double-digit inflation in the 1970s and 1980s, see below. But all in all I think this picture should illustrate just how important Keynes’ and Friedman’s insights into stabilization policy were (although they obviously approached the problem from different ends of the spectrum).
Secondly, lets take a look at the circled area. For ease, lets look at the shorter time frame in figure 2. The circled area I think is interesting because of what it says about the character of stabilization policy over the past 30 years. Firstly, it’s quite striking how stable the growth in nominal GDP is up to 1970 – the time series is almost a perfect linear trend over this period. However we can see that between 1970 and 1980 the growth in NGDP takes off – a result of the oil price spike but most significantly the higher inflation which resulted from the overly expansionary policies based on the miss-specified Phillips I mentioned above. Specifically, the belief that there was a permanent trade-off between unemployment and inflation, before the rational expectations revolution and the accelerationist hypothesis sprang forth, and was incorporated into policy making, led to higher and higher inflation. However, from 1980 the higher inflation was curbed very successfully and nominal GDP growth once again returned to a stable linear trend.
To sum, this series shows two very distinct advances in macroeconomic management. The first we discussed saw the introduction of a far more active demand management policy, the second saw the realization that there was no long-run trade-off between inflation and unemployment/output, and thus represented a refinement of Keynes’ and Friedman’s original breakthroughs. Both changes came after sudden periods of poor economic performance.
The question is, what will the next period look like?
Finally, the notion of adopting a nominal GDP level target is receiving more and more traction all the time. With this in mind its important to remember how stable a period in terms of economic growth the last 50 years have been up to 2008. Then look at how stable nominal GDP growth has been over the same period. Minus the set back in the 1970s, the log of nominal GDP has followed an almost perfect linear trend.
Its by no means enough to immediately change how we conduct monetary policy, but such exploratory analysis suggests a stable growth rate for NGDP levels is potentially an important part of establishing a stable macroeconomic environment.