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Thoughts on GDP and inflation

Today's revisions to Q2/11 GDP growth were relatively small and thus not very significant, but I thought this chart was interesting. Note how nominal GDP growth has been running right around 4% for the past seven quarters. It's the composition of nominal GDP growth that has changed; real growth has declined, while inflation has risen (inflation being the difference between the blue and red bars). Put another way, the rise in inflation has corresponded to a decline in growth.

This chart plots the quarterly annualized rate of inflation according to the GDP deflator, the broadest measure of inflation available, and it makes the recent rise in inflation really stand out. We left deflation behind once the recovery started in the summer of 2009. All measures of inflation have risen meaningfully since then. Inflation is not yet at scary levels, to be sure, but it is a fact of current life. We're not really in "stagflation" mode yet (inflation is still too low to be a big concern), but if nominal GDP rises from here without a meaningful pickup in real growth, then it would be the 1970s deja vu.

Note also how inflation by this measure rose from a low of 1.1% in late 1998 (when real growth reached 5.0%), to a high of 4.7% in March '07 (when real growth dipped to a low of 1.2%). This runs directly counter to what the Fed's Phillips-Curve inspired theories of inflation predict: strong growth does not lead to rising inflation—rather, low inflation leads to strong growth, and weak growth lends itself to rising inflation.

This is just one more way of saying that the Fed's efforts to stimulate the economy with easy money and artificially low interest rates are more likely to stimulate inflation than they are to stimulate real growth.

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