We hear economists calling for higher inflation to lower the burden of debt on borrowers. Yet, we hear them complain about slow real GDP growth too. (secular stagnation)
Can we have our cake and eat it too? Can we get real GDP growth alongside inflation?
Real GDP rose by 3.6% on an annual basis for 3rdQ-2013. Yet, half of that rise was inventory accumulation. What is going on? Well, we know that China is increasing its capacity to produce by huge amounts every year. We also know that exports from China to Europe have been falling. (source) We also know that Chinese imports into the US are growing. (source) Maybe China is dumping excess supply at competitive prices onto the US market. Maybe Chinese companies are competing heavily for market share in the US. Maybe China thinks the US economy is ready to increase consumption.
To have such a large increase in inventory could mean there are cheaper prices coming. And with most people complaining of low inflation, one could imagine that the large inventory might lead to lower prices… even lower inflation.
So the 3rdQ increase in real GDP could mean lower inflation.
What is the relationship between inflation and real GDP growth?
As the economy grows, real output grows. And the value of output grows. More money is required to incorporate the increased production at stable prices. Thus inflation is controlled as real output grows. This process is considered healthy for the economy.
Normally one can think that inflation stays low as real output is growing. Then as real output reaches its natural level and begins to slow down, further increases in demand tend to show up as price inflation. So inflation rises as real output slows down.
But the relationship between the growths of inflation and real GDP are not precisely like this. Here is a chart for the two.
Inflation is the blue line. Real GDP is the red line. You can see many times when they move opposite to each other. But you can see times when they move together.
Moving forward, we cannot rely on inflation to grow seriously. Will real GDP, gross “domestic” product, increase enough for employment? Can we produce more here in the US? Not really, the US consumer on balance gets weaker and weaker, as labor’s share of real output declines. Lower prices from China are too tempting. US consumers have less power to purchase the value of their own production.
It seems to me that we will get neither substantive inflation nor real GDP growth.