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Why price inflation in developed countries is systematically underestimated

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  • Kitov, Ivan

Abstract

There is an extensive historical dataset on real GDP per capita prepared by Angus Maddison. This dataset covers the period since 1870 with continuous annual estimates in developed countries. All time series for individual economies have a clear structural break between 1940 and 1950. The behavior before 1940 and after 1950 can be accurately (R2 from 0.7 to 0.99) approximated by linear time trends. The corresponding slopes of regressions lines before and after the break differ by a factor of 4 (Switzerland) to 19 (Spain). We have extrapolated the early trends into the second interval and obtained much lower estimates of real GDP per capita in 2011: from 2.4 (Switzerland) to 5.0 (Japan) times smaller than the current levels. When the current linear trends are extrapolated into the past, they intercept the zero line between 1908 (Switzerland) and 1944 (Japan). There is likely an internal conflict between the estimating procedures before 1940 and after 1950. A reasonable explanation of the discrepancy is that the GDP deflator in developed countries has been highly underestimated since 1950. In the USA, the GDP deflator is underestimated by a factor of 1.4. This is exactly the ratio of the interest rate controlled by the Federal Reserve and the rate of inflation. Hence, the Federal Reserve actually retains its interest rate at the level of true price inflation when corrected for the bias in the GDP deflator.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 39059.

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Date of creation: 27 May 2012
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Handle: RePEc:pra:mprapa:39059

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Keywords: real GDP; price inflation; interest rate; central bank; developed countries;

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  1. Ivan Kitov, 2007. "Real GDP Per Capita in Developed Countries," Mechonomics, Socionet mechonomics5, Socionet.
  2. Guglielmo Maria Caporale & Luis A. Gil-Alana, 2009. "Long Memory in US Real Output per Capita," CESifo Working Paper Series 2671, CESifo Group Munich.
  3. Laura Mayoral, 2006. "Further Evidence on the Statistical Properties of Real GNP," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 68(s1), pages 901-920, December.
  4. repec:ebl:ecbull:v:3:y:2008:i:2:p:1-11 is not listed on IDEAS
  5. Beechey, Meredith & Österholm, Pär, 2008. "Revisiting the uncertain unit root in GDP and CPI: Testing for non-linear trend reversion," Economics Letters, Elsevier, Elsevier, vol. 100(2), pages 221-223, August.
  6. Vougas, Dimitrios V., 2007. "Is the trend in post-WW II US real GDP uncertain or non-linear?," Economics Letters, Elsevier, Elsevier, vol. 94(3), pages 348-355, March.
  7. Michelacci, C. & Zaffaroni, P., 2000. "(Fractional) Beta Convergence," Papers, Banca Italia - Servizio di Studi 383, Banca Italia - Servizio di Studi.
  8. Dan Ben-David & Robin L. Lumsdaine & David H. Papell, 1998. "Unit Roots, Postwar Slowdowns and Long-Run Growth: Evidence from Two Structural Breaks," NBER Working Papers 6397, National Bureau of Economic Research, Inc.
  9. Juan Carlos Cuestas & Dean Garratt, 2008. "Is real GDP per capita a stationary process? Smooth transitions, nonlinear trends and unit root testing," Working Papers, Nottingham Trent University, Nottingham Business School, Economics Division 2008/12, Nottingham Trent University, Nottingham Business School, Economics Division.
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