A Quest for the ‘Missing Equations’ in OECD Countries

Abstract

This chapter searches for the determinants of nominal income elasticities of total output and the price level in the postwar time series of some OECD countries. The elasticities indicate how annual changes in nominal GDP are divided between output changes and price level changes. This concept was described by Gordon (2009, ch 7) as one of unresolved questions in macroeconomics, since the time of Keynes (1936, chs 20, 21) and Friedman (1970, 1971). Friedman (1970) presented two macroeconomic models, one quantity theory and another income-expenditure theory, where the former system is closed by the assumption that total output is constant, and the latter by the assumption that the price level is constant. Friedman called either assumption a ‘missing equation’, but the term missing equation could be generalized to imply the equation involving intermediate situations between the two theories, which determines the proportions of output and price changes which accompany nominal income changes, because, as Friedman wrote in Gordon (1974, p. 45), ‘the chief defect that this model [in Friedman (1971)] shares in common with the other two [that is the above two models] is that none of the three [models] has anything to say about the factors that determine the proportions in which a change in nominal income will, in the short-run, be divided between price change and output change …’