Economic Decisions Need Good Economic Models

Is bad economic decision making the product of flawed economic measurements?

How big is the world economy? That sounds like a straightforward question. Simply to add up the size of all the world's national economies would seem to be the obvious way to answer it. But how that is done yields radically different results, and therein lies a tale. The most commonly used method is to convert national economic outputs to a single measure, namely the American dollar, using the market exchange rates of all the national currencies. That produces a figure of $36 trillion for 2003. But many professional economists think that it makes much more sense to use what they call purchasing-power parities (PPP), which take account of differences in prices of the same goods between countries, and so tries to measure the real purchasing power of inhabitants in each country, no matter what the world's fluctuating currency markets happen to be doing to exchange rates. Using this method, the world economy last year was worth $50 trillion.

The precise size of the world economy may not matter much from a policy point of view, though a $14 trillion difference is hardly small change. However, which method of measurement is used also affects more important matters: the global rate of growth, the relative size of economies, and the extent of inequality between rich and poor. In these cases, using market exchange rates can produce misleading results and hence stimulate bad policies.

Interesting point. It is like the "jobs" debate we are having now. Some of these things are inherently difficult to measure and understand.

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