UNIVERSITÄT POTSDAM - Prof. Dr. Paul JJ Welfens

If purchasing power parity holds for tradables (T) in the form of e P T * = P T and
if we define P=(P T ) ß (P N ) 1-ß , then ge + gPT* = gPT and therefore gP = gPN + ß(ge + gPT* -
gPN) so that we obtain the growth rate of tradables prices as the difference between the
inflation rate and the change of the relative price ratio (ge + gPT* - gPN) weighted by ß.
According to (III) for a constant nominal interest rate and a given growth rate of
the money supply it holds that the inflation rate is the smaller the higher the growth rate
of real output and the stronger the increase in the ratio of stock market capitalization
relative to output. The coincidence of high growth and exceptionally growing stock
market capitalization – relative to output – could indeed explain the inflation puzzle in
the US in the 1990s.
Growth Analysis in a Two-Sector Model
Why was growth so high in the US in the 1990s? We consider a two-sector economy so
that overall output Y is composed of the ICT sector (sector 1) which accounted for
about 10% in the US in 2000 while the US recorded only about 6%. Denoting the relative
price P1/P2 as q” we have
(IV) Y = q”Y1+ Y2,
Assuming that sector 2 is the consumption sector, then output in terms of consumption
units is given by
(IV.I) gY = (Y1/Y) [gq” + gY1] + (1-(Y1/Y)) gY2
From this equation it is clear that the relative fall of computer prices reduces
overall growth as measured in units of the consumption good. For statistical purposes
the real output growth rate is measured in a different way, namely on the basis of constant
historical prices:
(IV.I’): gY = (Y1/Y) [gY1] + (1-(Y1/Y)) gY2
Here we can directly see that the high growth rate of the US is partly related to
the higher share of the ICT sector in overall output and partly due to the high output
growth rate of the ICT sector. The US statistical system has made two changes in the
1990s which go beyond the above formula but which almost have no net effect. Introducing
a chain-weighted index – reducing the well-known problem of substitution in
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