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Nominal versus Real GDP

by on 16/03/2018

The major threats to economy comes from the accumulated debts of currency regions either of the public sector or the private sector. It is important to define economy according to currency region and not anymore national economy.

While the private sectors debt have their natural limitations, meaning limited to the capacity of the private entity, either businesses or households to repay contractual interest and principle liabilities, the public debt seems to be immune to this problem. The exception is the Euro region with some individual countries, namely Italy with about 130% debt out of GDP, without sovereign currency, have no capacity to cover payments of these debts by printing money. This may cause major disruption in the whole European economy.

Yet the public debt is not immune from causing other economic problems, like increased inequality in income and wealth by enriching non-monetary assets holders as compared to monetary asset holders (wages and pension incomes). As well as causing propensity to more intensive volatility in assets prices and tendency to boom and bust states in the economy.

It seems, too little attention is given to the new reality of decreasing gap between the nominal and the real GDP since 2008 due to relatively low inflation. (The terms GDP in nominal or real prices is rather confusing. Real prices are used to compare annual Change in real terms between different time periods. Nominal prices are just prices on the shelves. The price reduction of products due to technologies causes relative decrease of nominal GDP. If not price reductions of technological items, the nominal change of the GDP would grow, tax collection would grow as well, and the debt in real terms would decrease. Inflation is beneficial for borrowers, and the government. As to the banks, as a go between the borrowers and lenders, they are as if not influenced by the inflation, but inflation reduces the risk on the loans, because of reduced debts burden.)

If in the past the price change index could be significant, in the last decades, the price index of consumers basket has hardly changed and with it the nominal GDP is close to the real GDP change. Since loans and their repayment are in nominal terms, it may seem as good news for the lenders and bad news for the borrowers. But this also adds instability and unsustainablity to the system. Stagnant prices and low nominal GDP growth, cause less tax income and higher debt burden of the business and private households. So no good news here. But it doesn’t mean good news for the lenders either. Close to zero interest rates, if raised, increased debt exposure, due to non inflating economy, together with the intensity in non-monetary assets prices volatility will cause necessarily unstable economy. So eventually if systematic exaggeration of debt, be it public or private, it will cause major disruption in the whole monetary system in form of system collapse.

At 2008 exactly this what happened, when the overdebted private sector in US, ceased to have capacity to repay its debts. To save the economic system, this debt was transferred, relatively smoothly from private debt to public debt. As to Europe, even if as whole Europe was not in US level debt, relatively small debt of Greece could endanger the whole Eurozone monetary system. It’s not hard to imagine, what will happen, if Italy, with 2 trillion GDP economy, would come to similar situation as Greece.

But the US public debt has also it’s limits. If with today’s close to zero interest rates this debt is still sustainable, it doesn’t have to be true when and if the interest rate will grow. If again deflationary pressure would appear, if the interest rate will be limited to positive values, it is hard to see how could the Federal reserve continue it’s policy of quantitative easing, without intervention to fiscal side of the economy, by purchasing sectoral based securities, like mortgage based or big corporate securities. On the other hand negative interest rate created artificially by government involvement, could disrupt the whole monetary system. After all you can fool sometimes someone, but not all the time everyone.

Since the real GDP growth is limited by non economic factors like, demography, resources limitation, lack of demand, the solution is nominal GDP growth. For the US, currency depreciation can be also a solution, the question is what it will do to other big economies, based on export to the US, like China and other Asian economies.

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