How much nominal overheating?



NGDP is up 12.4% over the past 9 quarters, an annual rate of 5.3%. That’s too high.

Nominal gross domestic income (NGDI) is up 16.1% over the past 9 quarters, an annual rate of 6.9%. That’s way too high.

Nominal total wages and salaries are up 17.1% over the past 9 quarters, an annual rate of 7.3%. That’s way, way too high.

Interestingly, NGDP and NGDI are exactly the same concept, measured in two different ways. The two figures would be identical if there were no measurement errors. Studies suggest that an average of the two is more accurate than either figure viewed in isolation, and future revisions of NGDP tend to move toward that average.

In this case, the average of NGDP and NGDI growth has been 6.1% over the past 9 quarters (i.e. from 2019:Q4 to 2022:Q1).

But labor compensation is probably a better indicator of macroeconomic stability than NGDP. So it’s worrisome that this figure is even higher (7.3% annual rate).

I usually focus on NGDP out of sheer laziness, and also because it is normally quite similar to NGDI. The past few years have been quite unusual, however, with a surprisingly large divergence between the two. In this environment it probably makes sense to take the average of the two, which suggests that demand overheating is even greater than I had assumed. This is especially the case given that a leading alternative (total nominal wages and salaries) shows even more overheating than NGDI.

The Eurozone is also suffering from high inflation, but their NGDP situation is quite different. Eurozone NGDP growth has averaged only 2.7% over the past 9 quarters, which is close to their trend. Of course NGDP is not a perfect indicator, and it’s possible that the Eurozone economy has also overheated slightly (unemployment recently fell to record lows), but it’s clear that the major problem in Europe is on the supply side. The Ukraine war has hit Europe much harder than the US. (Japan has not had any NGDP growth, and has relatively low inflation.)

I would add that while the ECB does not have a dual mandate, they do allow temporary deviations from 2% inflation when there are supply shocks. Here’s Philip Lane of the ECB:

[I]t should be recognised that the prevalence of downward nominal rigidities in wages and prices means that surprise relative price movements should mainly be accommodated by tolerating a temporary increase in the inflation rate, rather than by seeking to maintain a constant inflation rate that could only be achieved by a substantial reduction in overall demand and activity levels.[4] Since bottlenecks will eventually be resolved, price pressures should abate and inflation return to its trend without a need for a significant adjustment in monetary policy.

The logic underpinning a hold-steady approach to monetary policy is reinforced if the bottlenecks are primarily external in nature, caused by global disruptions in supply or a surge in global demand. Since monetary policy steers domestic demand, a tightening of monetary policy in reaction to an external supply shock would mean that the economy would be simultaneously confronted with two adverse shocks – a deterioration in the international terms of trade (generated by the increase in import prices) and a reduction in domestic demand.



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