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So you don’t believe in using PPP data?

Summary:
Is the Chinese economy larger than the US economy? In nominal terms (measured at current exchange rates), the Chinese economy is only about two-thirds the size of the US economy. In purchasing power parity terms (adjusting for differences in prices), the Chinese economy is actually larger than the US economy.  That’s because China has much lower prices. Over the years, I’ve seen numerous commenters make the following two claims: 1. Economies should be compared using market exchange rates, as this shows a country’s ability to buy goods in global markets, or the purchasing power of its tourists when they travel overseas.  Or it is more “objective”. 2. While Japan’s GDP has grown very slowly in recent decades, because of a falling population they haven’t done poorly

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Is the Chinese economy larger than the US economy? In nominal terms (measured at current exchange rates), the Chinese economy is only about two-thirds the size of the US economy. In purchasing power parity terms (adjusting for differences in prices), the Chinese economy is actually larger than the US economy.  That’s because China has much lower prices.

Over the years, I’ve seen numerous commenters make the following two claims:

1. Economies should be compared using market exchange rates, as this shows a country’s ability to buy goods in global markets, or the purchasing power of its tourists when they travel overseas.  Or it is more “objective”.

2. While Japan’s GDP has grown very slowly in recent decades, because of a falling population they haven’t done poorly in per capita terms.

But each claim is defensible, considered in isolation. On the other hand, these two claims cannot possibly both be true.

Here is a graph showing the nominal GDP per capita in the US and Japan since 1994, in local currencies:

So you don’t believe in using PPP data?Japan’s nominal GDP (blue line) is up a total of only about 8% in 24 years.  That’s nominal GDP.  In contrast, the US is up more than 125%.  Of course that doesn’t necessarily mean Japan is doing poorly, these are nominal GDPs and they’ve had some deflation.  But now suppose you are one of those people who believes that the relative GDPs of countries should be compared using market exchange rates, as these are somehow more objective.

This graph shows the same NGDP per capita data, converted into the same currency (yen in this case, although you’d get the same disparity using dollars):So you don’t believe in using PPP data? Now the gap is even larger, with the US up 145% in 24 years, while Japan’s GDP per person is up only about 8%.  Relative to Americans, the Japanese are considerably less than half as rich as 24 years ago.  If these figures are the correct way to compare countries, then Japan has experienced a Great Depression that makes America’s experience during the 1930s seem like just a bump in the road.

Let me hasten to add that I don’t believe these figures are meaningful.  But you’d be forced to accept my analysis of Japan if you want to argue that market exchange rates are the best way to compare the size of the US and foreign economies.

I often see news media outlets claim that China has the world’s second largest economy.  It’s a free country, and they are entitled to use market exchange rates if they wish.  What the media should not do is argue that China is the world’s second largest economy, and then not report that Japan has recently experienced an economic collapse of epic proportions.

But of course that’s exactly what the media often does do.  Just one more example of how much of what you read in terms of economic reporting is highly misleading.

Use PPP data, or don’t use PPP data.  But make up your mind.

PS.  Japanese tourists visiting Hawaii really have experienced a Great Depression.  Because inflation has averaged about 2% in America, and because the $/yen exchange rate has been fairly flat, and because nominal incomes in Japan have been fairly flat, their yen buy a much inferior Hawaii vacation compared to what Japanese tourists were able to purchase in 1994.

PPS.  You may wonder why my data seems so different from what you may have read about Japan’s real GDP per capita growing at a reasonable rate.  The answer is simple; Japan’s real exchange rate has plummeted over the past quarter century.  That’s why Japanese tourists now seem so much poorer than in 1994.  People don’t notice the astounding change in the real exchange rate because the nominal $/yen exchange rate has not changed very much over 25 years.  Money illusion.

So you don’t believe in using PPP data?

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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