Not so long ago, the consensus of the economics profession was that economic growth above some “sustainable” level (typically given as 2 1/2%), would create shortages and bottlenecks that would lead to price inflation. Accelerating price increases would then, it was believed, force the Federal Reserve to choke off growth with tight money and high interest rates.

Economic growth has been reported at rates in excess of 4% per year for most of the 1990s without a significant acceleration of reported price inflation. This has been explained as a reflection of productivity growth, which has enabled employers to increase wages without increasing their labor costs per unit of output. It should be noted, however, that the numerator of the measures of productivity is constant dollar output. This means that both the unexpected phenomenon, sustained growth rates well in excess of 2 1/2% with little increase in price inflation, and its explanation, higher productivity, could vanish if the rate of price inflation was understated.

The preliminary estimate of total output of goods and services in the United States for the third quarter was 7.7% more than during the third quarter of 1999, and is subject to revisions based on additional and more complete data. However, such estimates are probably as accurate as is humanly possible. There are simply too many people involved in the collection and compilation of the National Income and Product Accounts (NIPAs) for a plot to “cook the books” to remain secret for long. The problem lies in determining how much of that 7.7% increase reflected higher prices, how much reflected higher spending, and how much of that higher spending was for better and entirely new products. This is not a simple question to answer.

The current official estimate is that prices increased 2.3% from a year earlier and that spending increased 5.3%. The latter estimate involves adjustments for quality changes. The notion being that, say, the change in the cost of a car may reflect features that improve the vehicle’s serviceability, performance, or convenience, as well as changes in the price of the basic product. Such adjustments are subjective and arbitrary, and they may have become even more so during the past 10 years of rapid technological change. For example, the speed and memory capacity of computers has increased markedly and continues to do so. This fact is reflected in the rapidly decreasing computer prices used to compile the “real” GDP estimates, but it may not be evident in the dollar price that someone who only uses a personal computer for word processing and e-mail (who may not use or need the faster speed and larger memory) will pay to replace his machine.

We do not pretend to have better answers to these kinds of questions, but it is clear not only that they are central to how we view our economic performance, but also that they are generally ignored in popular discussion Consider, for example, how different the current election campaign or debate over Federal Reserve policy would be if the components of 7.7% nominal growth were reversed—2.3% economic growth and price increases of 5.3%.

Also in This Issue:

Quarterly Review of Investment Policy
Gold Fields
Small is Beautiful
Alternative High-Yield Dow Investment Strategy
The Dow Jones Industrials Ranked by Yield
Recent Market Statistics