WHAT MATTERS MOST: What a puzzle!
A friend of mine who says he is calling to pick my brain called when he heard that the economy had grown by an estimated 2.8 per cent in real terms for the first quarter.
Not that he was not happy to hear the news. But he was as puzzled as he was surprised, given how business has been going. He really wanted to understand how the economy was measured and what was meant by real.
I asked if he had a weighing scale in his bathroom and he said yes. I asked, “Do you believe that the scale gives you an exact measurement?” and he said, “No.” I then asked, “Do you feel that in spite of that the scale can tell you whether or not you are losing or gaining weight?” and he said, “Yes.”
The answers to the questions allowed me to use the bathroom scale to explain that no economy is measured with total certainty, but once the error remains standard, different periods may be compared – that is, year compared to year, quarter to quarter and so on.
I then used the way in which he is weighed to explain the difference between a nominal measure and a real measure. If he goes on the scale in shoes and other clothing, this may be likened to a nominal measure. When he removes all of the clothing, he is getting a real measurement.
In more technical jargon, the removal of the clothing is the deflator – that is, the thing used to convert the nominal measure to a real measure. For the economy, a price index is used to change the economy’s nominal size to its real size.
The importance of the price index is simply that the real spending power of a dollar changes with the prices in the supermarket. When the prices rise, the dollar has less purchasing power; prices hardly ever decline.
One of the ongoing curiosities in Barbados is that the Barbados Statistical Service measures the nominal size of the economy on an annual basis while the Central Bank of Barbados measures the real size.
Furthermore, the Central Bank alone is responsible for the quarterly measurements of the real economy.
Now the price index, which allows the bank to deflate the nominal economy, ought to be a special kind of index, but in the absence of this special index the consumer price index becomes a proxy. Like the bathroom scale, the issue is not necessarily its accuracy but whether or not it is moving in the right direction.
Of course, unusual things can happen. For example, if for whatever reason prices decline, then the real size of the economy could actually be bigger than the nominal size in a given time period.
This would be tantamount to going to the supermarket and discovering that your dollar can now buy more than it bought before. This would be highly, highly unusual.
On our bathroom scale, this would mean that the clothing actually weighs a negative value. In essence, my friend would weigh more with his clothing and shoes off than he would with them on.
Given the above, I could well understand why my friend was puzzled. Prices have been growing in Barbados and are expected to continue growing; therefore, the nominal size of the economy would have to be growing more than prices for there to be real growth in the economy.
Therefore if you – the public – were told some time soon that the Barbados economy grew in real terms because prices had declined, you would be as puzzled as my friend.
Given that two different institutions measure the nominal and real size of the Barbados economy, it is not inconceivable that such a position may be reached to the amazement of the people.
Prices declined in the Barbados economy in 2010 and during the first quarter of 2011. Amazing!