Nick Rowe raises an interesting question about the chart I posted earlier appearing to show that the performance of the pre-2010 Greek economy was, while hardly stellar, nothing like the train-wreck you might expect based on the public discussion surrounding the Greek financial crisis. The question, as I understand it, boils down to this: could the microeconomic effects of Greek government borrowing (i.e. its impact on relative prices) affect the measurement of macroeconomic variables (particularly real GDP)? And, if so, should the effects be regarded as "fake?"
I think the answers are "yes" and "no," respectively.
The "yes" part is fairly easy to see. French and German banks loaned money to the Greek government that, otherwise, would have been loaned to and spent by somebody else. There's every reason to suppose that the different "candidate spenders" would have bought different things, so the choice of spenders has an effect on the relative prices of stuff they buy.
Changes in relative prices affect real GDP. The effect is most visible in cross-country comparisons on a purchasing power parity (PPP) basis, but it also plays a role in "longitudinal" real GDP within a single country.
To see how this works in the cross-country case, consider Saudi Arabia. The real value of its output in any given year depends rather a lot on the real price of a barrel of oil. A real rise in the price of oil (i.e. in increase in the nominal price of oil that outpaces the rise in the general price level) makes Saudi output more valuable, in terms of the goods and services produced by the rest of the world, even if the quantity of oil in that output is unchanged.
The effects of relative price changes on longitudinal real growth rates within a single country are more roundabout. Conceptually, a national real GDP growth rate is a weighted average of the growth (in quantity) of output of each good and service produced. We naturally want to weight each product-level growth rate in accordance with the importance of that product in the overall economy. That, it turn out, we usually measure by the share of each product in nominal output, which may be affected by its price.
Considering the Saudi example again, a rise in the price of oil (if not completely offset by a reduction in quantity) would increase the weight of the oil industry's growth rate in the calculation of the national growth rate. If the output of that industry is rising faster than average (1), this will tend to raise the measured growth rate of the country, but if (as is entirely possible) output of the oil industry is growing slower than average, an increasing price will tend to decrease the measured growth rate of the country as a whole.
The take-away is that real GDP is always and everywhere affected by the relative prices used to calculate it. (The difference between nominal and real GDP is not that the latter excludes the influence of relative price changes, but that it excludes the influence of changes in the general price level, i.e. inflation. (2) )
Does that mean that real GDP is "fake?" Only if you imagine that real real GDP would be somehow unaffected by relative prices. But how could that be? How do you add up the quantities of compact cars, bars of soap, and haircuts an economy produces every year without relying on relative prices? (My proposal to measure the output of all goods and services in metric tons, thereby giving proper meaning to the term "weighted average," has so far garnered little support.)
But what about the real question: would balancing the Greek government budget inevitably reduce the Greece's real GDP vis-a-vis the rest of the EU, on a PPP basis, even if the impact on aggregate demand was fully offset?
I think the answer is no. Even assuming, as Nick suggests, that balancing the Greek budget would reduce domestic demand for Greek tradeables enough to lower their EU-wide prices, it's not clear what the impact of the offsetting increases in aggregate demand would be. If, as seems plausible, that the offset came largely in the form of increased demand from the rest-of-the-world for Greek exports, the price of Greek tradeables might not fall after all, and might even rise.
The bottom line is this: if "austerity" is simply a re-arrangement of aggregate demand for Greek goods and services (i.e. a change in who does the spending and in the mix of what they buy), as it should be, there's no reason to assume that the reallocation has to lead to a net decline in relative, PPP-based GDP.
(1) I.e. the weighted average growth rate of all other industries.
(2) I think Nick may have inadvertently muddied the waters here by thinking about the question through the prism of exchange rates. The Canadian example with which he begins his post involves an across-the-board change in all prices (because they are measured at a market exchange rate which has fallen). Naturally, that change appears "fake," just as if we decided to measure GDP in pennies rather than dollars ("Look! It's up by a factor of 100!"). But the difference between a change in the price level and one in relative prices is a crucial one in this context.