Yesterday the US Bureau of Labor Statistics reported a gain of 528,000 jobs and an official unemployment rate of 3.5%. This against two consecutive quarters of declining real GDP. How to square the circle?
Longtime readers have heard the basis for it before. So-called “real” GDP is calculated by starting with nominal GDP and backing out inflation. Logical, right? But the accuracy of the derived statistic depends on getting both inputs right. And as we have pointed out ad nauseum, the economics community doesn’t get inflation right. It’s reckoning of “inflation” is based on one narrow subset of prices – US domestic consumer prices – and this subset is a lagging indicator. So as inflation rises, it systematically understates inflation, with the result that inflation is not fully backed out of nominal GDP. That in turn leads to GDP being overstated. This is the genesis of the myth that easy money stimulates the economy. Through this distorted lens, rising inflation looks like real growth.
The opposite happens on the way down. The use of an overstated inflation figure results in real GDP being understated. The tightening of financial conditions due to the collapse in bond prices over the first half of the year has brought inflation down, but it has yet to be fully reflected in lagging consumer prices.
With this insight, we can settle the question … between these two sharply dissonant statistics, on one hand collapsing real GDP versus on the other soaring employment, which one is wrong?
Collapsing GDP. We have not had two quarters of declining real GDP.