Wednesday, November 27, 2013

Let's set our sights lower, he says

Oh for crying out loud. John B. Taylor moved from this blog to this one, and evidently didn't bring all his old posts along. So in order to re-read his post of 6 Feb 2012 I had to go there and quickly capture the page source before his timer timed out and deposited me at the error page.

This is what I wanted from JohnBee's post:
The first chart shows real GDP during the 10 quarters since the end of the 2007-2009 recession along with CBOs recently revised estimate of potential GDP. The chart clearly shows that the economy has yet to recover back to its potential. The only real difference from earlier assessments is that CBO has slightly lowered its estimate of potential.

For comparison, the next chart shows the recovery back to potential in the 10 quarters following the 1981-82 recession. The difference between the two charts is striking, and is why one can say that the current recovery is a recovery in name only.

In the second graph, the Reagan years graph, Real GDP quickly works its way back up to Potential GDP. In the first graph it does not, despite the fact that "CBO has slightly lowered its estimate of potential," as Taylor says.

Mmm, they do that, CBO. They have to lower potential GDP if real GDP fails to work its way back up to potential, because

CBO assumes that any gap between actual GDP and potential GDP that remains at the end of the short-term (two-year) forecast will close during the following eight years.

The two lines have to meet in ten years. So if real GDP refuses to go up, potential GDP has to come down. As the creepy guy in Beverly Hills Cop said, "How nice."

John Cochrane looked at Taylor's graphs and said:

We usually bounce back to the trend line. Now, we're not.

Well, he's right about that.

In a speech to the Union League Club of Chicago (PDF, 6 pages) James Bullard said:

The FOMC has adopted an explicit, numerical inflation target. This is an important development, as it may prevent the U.S. from repeating the mistakes of the 1970s, in which a misreading of the size of the output gap led the Fed to maintain easy monetary policies for far too long...

I have argued that the “large output gap” benchmark, in which current economic performance is continually compared to the bubble-influenced mid-2000s, may not be realistic. Instead, one may want to interpret the recent U.S. experience as a one-time, permanent shock to wealth.

In other words, Bullard is saying that we shouldn't draw Potential GDP way up high like it shows on the first of Taylor's graphs. We should draw it lower, to make a reasonable target that real GDP can reach. Let's set our sights lower, he says.

As Taylor noted, that *is* what's happening. We looked at it yesterday.

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