Q69. What is liquidity?

At any moment, in any economy, there is a stock of money sitting somewhere - usually in a bank and usually controlled by the Central Bank. When I buy something from you, say an apple, for €1, I lose €1, and you gain €1. But the stock of euros is unaffected.

The stock of money in an economy at a given moment is the amount found by adding up the cash in everyone's pockets and the amount they have on deposit (the money owed by banks to their customers), and the amount banks have that they are willing to lend to other customers.

There are lots of different measures of this money stock. One is shown below for the Eurozone. This is called 'm3', and represents the sum of cash in circulation, deposits, and credit available. You can see clearly the percentage change in available cash from 1981 to 2010. There has been a drastic change in the liquidity available in the Eurozone since the beginning of the 2007 crisis.

Q70. What is Gross Domestic Product?

Following the Second World War, many countries decided to standardise their national income and product accounts, so they could compare how much each of them had produced in a given year.

The national income and product accounts of any country contain summaries of the amounts consumed, produced, invested, saved, imported, exported, and spent by the government, in a given year. The national income and product accounts also show the flows of funds between the different sectors of the economy. Gross Domestic product is the numerical sum (in today's prices) of the total consumption of goods and services, overall investment, and government expenditure, in that year. Because GDP is measured in today's prices, this measure of GDP is called nominal GDP. To take account of the movement of prices, nominal GDP can be divided by the GDP deflator to give real GDP.

However, GDP is not a measure of overall wellbeing. It is a flawed measure, since it does not take into account resource depletion, environmental destruction, inequality, the black (or grey) economy, or technological change.

One simple example is housework, which is largely unpaid. So, if the numbers of people doing unpaid housework changed, GDP would not change. Similarly, if everyone in the economy were to spend some of their free time cleaning the streets near their homes, GDP would be unmoved, but life would be better, as everyone would have a better environment and would enjoy it a little more. Despite these measurement problems, most policy-makers around the world are obsessed by GDP growth.

Most economists agree that the main way to enrich a country and its people is to create the conditions that allow it to grow its way out of poverty. The determinants of GDP growth are increases in the rate of capital accumulation through savings and investment, increasing rates of technological change, and a steady population growth rate. Because GDP is the sum of all final goods and services produced in the economy in a given year, the GDP growth of an economy can be measured by:

GDP Growth = ((GDPt-GDPt-1)/GDPt-1 )* 100.

So, for example, if GDP in 2006 was 105, and GDP in 2005 was 100, the growth rate of GDP would be:

((GDP2006-GDP2005)/GDP2005-1)*100 = ((105-100)/100-1)*100 = 5%.

Q71. What is the GDP deflator?

The Gross Domestic Product (GDP) deflator is a way of accounting for inflation. Related to index numbers, the GDP deflator shows how the cost of different bundles of goods would vary, holding prices constant. It holds base period prices fixed, in contrast to the Consumer Price Index, another measure of inflation, holds base period quantities fixed.

The GDP deflator is calculated by dividing nominal GDP by real GDP, and multiplying by 100. Many countries have their GDP deflators described at this link: bit.ly/GDPdeflator.

 
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