From Gavyn Davies at the Financial Times:
How much spare capacity does the world have left?
Most economists accept that developed economies have been operating considerably below potential GDP since 2008, but there is much less agreement about the size of the output gap, and what should be done about it. This is obviously crucial. The larger the output gap, the greater the waste of resources (and, from an investor’s point of view, the greater the scope for future growth). Furthermore, the larger the gap, the smaller the budget deficit when economies return to potential, so the greater the scope for fiscal expansion today.Here are the charts:
Keynesians have been focused on these issues for a while, and have generally had the better of the argument in the current recession. Recently, their thinking has been developing in some important respects. An example is Paul Krugman’s contribution to a panel discussion on the macroeconomics of recessions at the annual meeting of the American Economic Association in San Diego last week. (Brad DeLong, the panel chairman, has posted a transcript).
In his contribution, Professor Krugman asked the following question: if the output gap is really as large as the Keynesians have claimed, why has inflation not fallen into negative territory? In most developed economies, the core rate of inflation has stuck at about 2 per cent, despite the fact that real GDP has been about 10-13 per cent below its long-term trendline for several years in succession. Does this not tell us that potential GDP is in reality much lower than the simple extrapolation of previous trends would suggest?...MUCH MORE
Because of a long-ago diagnosed proclivity for putting foot-in-mouth (ya gotta see Thesaurus.com* to really get a feel for how bad my malady can be) exemplified on these pages by:
Atlanta Fed: "How Big Is the Output Gap?..."
I know the neo-Keynesians are all up in that as the young people say (in a slightly different context) but I've recently started thinking that the number is pretty much meaningless....Or some mighty fine bloviating on my part:
...If by "normal" the respondents are referring to the 2005-2007 bubble days I should hope things are down.
An economy built on 125% LTV mortgages, San Francisco realtors knocking down $600K or any of the other effects of the loose-as-a-goose lending and monetary policies of that long-gone era is, simply put, delusional.
If capacity utilization rates use capacity designed to feed the bubble you have an imaginary number as your denominator.
Besides not being sustainable, economic fantasy can be downright dangerous.
"Paul Krugman's Baltic Problem"
I've had problems with the so-called output gap for the last couple years. The usual presentation ends up drawing a line that tracks and extends the 2005-2007 trend line.
But what if the calculation of Potential GDP is wrong?
The methods for ascertaining Pmax can be divided into two large groups: 1)The GDP that would be attained if all factors of production in a country were utilized to their maximum capacity and 2) The GDP level corresponding to a growth rate sustainable into the medium and long-terms. The CBO does a good job explaining some of the methods to estimate potential GDP. Here is the usual presentation...
...The question to ask is: "Was that mid-2000's GDP real or an artifact of the unprecedented growth of debt in both the the public and private spheres?"
What if "Okun's Law" is actually just "Okun's Strong Suggestion"?
If GDP growth was fueled by unsustainable debt, it was a chimera and we had better re-figure our assumptions on what maximum output of the economy actually is.There are a few more, you get the point: Bombast "Я" us.
As Herb Stein used to say, “If something cannot go on forever, it will stop.”
Both The Economist and FT Alphaville looked at the growth question this year:
Limits to Growth: Is the U.S. Economy Running at Max Growth Rate?
A Strong Case That Economic Growth as We Know it Is Over
Growth may simply not be strong enough to employ the current labor force.
That means high levels of unemployment may be with us for a while.
Professor Krugman is an indefatigable champion of the output gap theory which may no longer be operative or even relevant..
With that pre-ramble here's the headline story from Foreign Policy...
But what if those charts above are right?
[cue creepy, scary organ music]
*Anyhoo, here's Thesaurus.com on my problem:
Foot-in-mouth
| Part of Speech: | adjective |
| Definition: | not proper, suitable |
| Synonyms: | bad form, disproportionate, garbage*, ill-fitted, ill-suited, ill-timed, improper, inapplicable, inapropos, incongruous, inconsonant, incorrect, indecorous, inept, irrelevant, left-field, malapropos, off*, out of line, out of place, tasteless, unbecoming, unbefitting, undue, unfit, unfitting, unmeet, unseasonable, unseemly, unsuitable, untimely, way off, wrong, wrong-number |
