Sunday, December 1, 2013

The Revision of Potential GDP

Jazzbumpa looked at mine of 26 November, and observed:
I took the data [and] made a composite of the various series in a couple of different ways... Either way, on log scale, I get a curve with decreasing slope ... Even viewed as a potential, GDP growth has slowed over time. Our economy is dying.

Look at growth rates instead, and you see the same picture.

This graph shows the growth rates for two estimates of Potential GDP, the January 2005 estimate and the February 2013 estimate. Eight years separate the estimates.

Some observations
1. Not a lot of difference in the early years.
2. A significant difference for some years before and after 2009
3. The blue line stops short at the end, but the red line seems to be on the same path.
4. The overall trend is downhill. Our economy is dying.


The Arthurian said...

I am uncomfortable leaving you with the thought that "Our economy is dying". I prefer to leave you with the thought that we can restore our economy's health and vigor if we use the right policies and -- mostly -- if we stop using the wrong policies.

geerussell said...


I'm interested to hear your impressions on this idea from a fun-with-charts blog post on potential GDP:

"Potential GDP is a reflection of how labor shares in the production of a country. If labor receives a larger share, potential GDP is higher. If labor receives a lower share, potential GDP is lower.

We can understand now why economists are just now figuring out that potential GDP is not so high as they thought, and that the output gap is not so high as they thought. They do not understand the effects of a lower labor share."

To me it seems to make a similar case to the one you outline but specifically linking it to labor share.

The Arthurian said...

I looked first at Potential GDP relative to Real GDP at FRED. The base-years differ, but the pattern of the ratio should be about right. That pattern reminds me of the unemployment rate.

Next, I found again something I read the other day, "Behind the Slowdown of Potential GDP" from the Cleveland Fed:

"In an accounting sense, there are three determinants of potential GDP—the capital stock, potential hours worked, and potential multifactor productivity—and changes in any one could be behind the slowdown of potential GDP."

So, if actual hours worked fall relative to potential hours, unemployment goes up and potential GDP goes down. I don't know how that fits with "labor share" though.

Third, I remembered Okun's law:

There is a grand similarity between the output gap and the employment gap. Again, this has more to do with the unemployment rate than with labor share, but I suppose there must be some relation.


As for what I can see for myself...

In the labor share graph I see a slow decline until about 2002, then a rapid decline.

In the Growth Rate of Potential GDP graph there is an anomalous improvement in the 1990s, midst a general decline. Does Lambert explain the anomalous improvement? I explain it as a result of changes in money growth and debt growth since the mid 1980s. If there are signs of the anomalous improvement in the labor share graph, they start late -- in the late 1990s. To me, that looks like a result, not a cause, of improved Potential.


You quote Lambert: "We can understand now why economists are just now figuring out that potential GDP is not so high as they thought, and that the output gap is not so high as they thought."

I'm not comfortable with that. Potential output -- if we can imagine such a thing -- cannot depend on what we understand and fail to understand. It must depend on economic conditions.

If policymakers misunderstand the economy and, because of that, they create conditions that are not the best, well, perhaps potential output (as we imagine it) must decline. But this decline is only the indirect result of policymakers' ignorance. It remains a direct result of conditions.

But maybe I read too much into Lambert's words.

JW Mason gets to the same place as Lambert: "Now for Summers and Krugman, there still exists a fundamentals-determined potential growth rate, and historically the level of activity did fluctuate around it in the past. Only in this new era of secular stagnation, do we have to consider the dynamics of an economy where aggregate demand plays a role in long-term growth."

But you can see Mason rejecting the concept of "a fundamentals-determined potential growth rate" while he emphasizes the role of aggregate demand.