Sunday, April 2, 2017

Assumptions and the Progress of Economic Growth

From Potential Output and Recessions: Are We Fooling Ourselves? (November 2014) by Robert F. Martin, Teyanna Munyan, and Beth Anne Wilson:

First, output typically does not return to pre-crisis trend following recessions, especially deep ones. Second, in response, forecasters repeatedly revise down measures of trend.

On average, GDP remains well below its previous trend, even for short and shallow recessions. Deep and long recessions, of course, lead to the largest cumulative output loss.

If actual growth returned to pre-crisis trend then growth immediately following recessions would be higher than average to make up the gap. In fact, the average growth in the four years after the recession trough is generally lower than prior to the pre-recession peak.

Economic models usually assume that recession-induced gaps will close over time, typically via a period of above trend growth. In our results, growth is not faster after the recession than before, implying that the recession-induced gap is closed primarily by revising estimates of trend output growth lower.
I thought that was pretty interesting.

They say

Economic models usually assume that recession-induced gaps will close over time...

Reminds me of an old CBO paper that says

CBO uses potential output to set the level of real GDP in its medium-term (10-year) projections. In doing so, 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.
So, yeah.

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