Economic survey: no economic target achieved in 2011-12

[Sa1eem]

Re: Economic survey: no economic target achieved in 2011-12

@Ali_Syed

Thanks for your input, and your post was really informative! I have two questions from this post:

1. First of all while calculating nominal GDP why would we use the values of USD different in Pakistan and US, is that due to the different purchasing power parities?

2. If we use nominal GDP for calculating different ratios like tax/GDP and loan/GDP ratios. Since GDP would be the price of goods and services produced over the year, so wouldnt increase in inflation would increase its value? Maybe the produce has decreased year to year but the inflation would be portraying as if the country is going strong.

You are welcome.

1. First of all while calculating nominal GDP why would we use the values of USD different in Pakistan and US, is that due to the different purchasing power parities?

Actual quoted currency of nominal GDP is rupee. But, internationally GDP are quoted in dollars (it is just a standard to have one currency for comparison of GDP between different countries). Traditionally, conversion of GDP was done using average value of dollar during that financial year. For instance, for GDP figure of FY 2010-11, the value of dollar would have been average value of dollar during FY 2010-11.

Anyhow, as currency movements could be abrupt in one year but stable during others, some world institutions have decided to take average value of last 3 years instead of 1 year.

So, value of dollar is taken same what it is in market. For Pakistan, this value would be average exchange value of dollar during last one financial year or last 3 financial years (whichever is preferred by one quoting GDP figure).

As for Purchasing power parity value, that is different matter. In past there was no GDP figure in PPP. Such figure without taking into account PPP was very misleading, as we know that $1000 (Rs 93000) in Pakistan has much more purchasing power than $1000 in USA. So, a method was devised so that GDP in purchasing power can be worked out and for that, GDP was normalised to purchasing power of US Dollar in USA.

2. If we use nominal GDP for calculating different ratios like tax/GDP and loan/GDP ratios. Since GDP would be the price of goods and services produced over the year, so wouldnt increase in inflation would increase its value? Maybe the produce has decreased year to year but the inflation would be portraying as if the country is going strong.

Not really. Actually, real GDP for the year is only used to calculate GDP growth rate compare to real GDP of previous year, nothing else. Inflation indirectly gets linked to real GDP and nominal GDP, both.

As you can realise that tax and debt are measured in current currency value so their value is linked with current value of GDP or nominal GDP.

Example:

Let say, I earn $15000 last year
and I earned $20000 this year

That means my income increased 33 percent (nominally)

Anyhow, let say inflation was 10 percent and that means my last year income in today’s value was $16500 (this year $16500 buys same amount of goods and services what $15000 could have bought last year).

So, to find real rise in my income I have to use $16500 for last years income and that means instead of 33 percent, my income increased ($20000 divided by 16500 =) 21 percent. That is real growth in my income, as after increase I can buy 21 percent more goods and services.

On the other hand, same can be done by reducing this year income to take into account inflation. That can be done by dividing $20000 by 1.10 = $ 18180.

Thus in real terms, my income increased to $18180 last year dollar (that is GDP value in last year dollars).

As for debt, if my debt today is $2000 then I would have to pay that using my income $20000, not $18180 … thus my debt to income ratio would be 2000:20000 … or 10 percent.

Same is about tax. Let say I pay 2000 dollar tax than it would be 10 percent of my income of $20000 and not income $18180 (where $18180 is my income value in last year dollar)