Nominal Income and the Inflation-Growth Divide

• Published in: Policy File 1997
• Main Author: Chand, Sheetal K
• Format: Report
• Language: English
• Subjects: Banking/Finance; Economic policy; International Monetary Fund

This paper is concerned with the macroeconomic issue of how to decompose nominal income into its inflation and output growth components. Several fundamental theories, which are very different and the source of much controversy, have been proposed. Despite the improvement in the power and sophistication of statistical tests, it has not been possible to discriminate conclusively among these theories. This paper suggests a different, hierarchical, approach for undertaking the decomposition. Starting with the nominal income solution, a rule is proposed for its decomposition into subsidiary inflation and output solutions. It possesses the useful encompassing property of being able to generate the basic rules in the literature by varying the values taken by the few easily estimated parameters. The suggested approach is applied to major industrial country data. The results obtained are robust and support the underlying causal assignment. They indicate that both prices and output respond to nominal income fluctuations, ruling out extreme Keynesian or classical positions, but also the Phillips curve. The countries sampled exhibited some diversity -- with some closer to a Keynesian, more output-oriented, longer-drawn-out dynamic adjustment response -- while others were more classical.