Thursday, September 27, 2012

The Empire of NGDP

The Empire of NGDP  is made up of two islands that have no commercial contact.

The first, called "Autarkia," is made up of self-sufficient corn farmers.   Each farmer grows and eats corn.   Land is plentiful, but weather is variable.   When the weather is good, the labor of the farmers is very productive.   When the weather is poor, not so much corn is produced.    They have quite good weather forecasts.   Expected productivity impacts how much corn is planted and how much the farmers work.

The other island, called "Speculativia" is made up of gold speculators.   There is a fixed stock of gold and a variable quantity of fiat currency.   People buy and sell gold for paper money.   There is, of course, a money price of gold.

Government officials, however, calculate an index number that shows the current price of gold as a percent of its value in a base year.  Just for fun, these same government officials multiply this index number by the annual production of corn on Autarkia, and call it nominal GDP for the NGDP Empire.

Nominal GDP is just a number calculated by multiplying two  "real" things.   Well, the annual production of corn is very much a real thing.   An index number calculated from the money price of gold is a "nominal" thing, but the money price of gold is something that happens in the real world and the index number is just an odd way of describing the money price of gold.

Nominal GDP, on the other hand, is just a product of two unrelated things.   Increase nominal GDP?   What do you want to do?   Get the farmers to plant more corn?   Or get those holding gold to sell less gold, or those holding money to buy more gold, and so increase the money price of gold and so the index number?

Clearly, it is only things that convince the farmers to plant more corn that result in more employment.  (The farmers spending more time cultivating their corn.)   Increases in the quantity of money might result in a higher money price of gold and a higher index number, and so higher nominal GDP, but what difference could that possibly make to the employment farmers or the production of corn?

That crazy Empire of NGDP.