Sunday, May 24, 2009

Replacing The GDP Gap Focus

My comment to Arnold Kling's blog post, "What is the GDP Gap?"

GDP is a flow measure comparable to business revenue. Next quarter's GDP does not capture the long-term gains from the economy's current restructuring and capital investment.

In addition to revenue, businesses have a second measure; the present value of all future income streams. For business, it could be market value based on its publicly trading securities or it can be a business sale value based on comparable prices for similar businesses.

Furthermore, business owners consider future sales and profit prospects as part of their business decisions.

The goal of GDP management should be a present value decision, but as far as I know, there are no stock measures of future GDP available. A stock measure would capture the benefits of an economy's restructuring and reinvestment during recessionary times.

It seems that focusing on GDP gap is equivalent to a business owner worrying about next year's revenue without considering the ongoing stream of future revenue and the value of the business.

It reminds me of the occasional criticism we hear against business that it worries too much about next quarter's earnings and not enough about the long term.

If we had some readily available present value measure of all future GDP, I think the focus on next quarter or next year's GDP gap would diminish. Economists that now focus on GDP gap would switch to discussions about the present value measure of future GDP. Maximizing GDP, while maintaining some politically comfortable level of unemployment, would become the goal of economists and government.

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