Long-Run Real GDP Forecasts: The Hopeless Task of Trying to Pierce the Veil of Time and Ignorance Weblogging: Focus
OK: Now that I am awake and coherent and caffeinated, we may resume…
I draw somewhat different conclusions from the wavering track of potential GDP since 1990 than do the viri illustres Steve Cecchetti and Kermit Schoenholtz:
First, I think that monetary policymakers should not be looking at potential output and the output gap at all. They should be looking at the labor market. You can determine whether monetary policy is such as to accord with people’s previous expectations and thus balance supply and demand in the labor market much more easily than you can track whether actual production and demand are above or below what your retrospective estimate of potential output will turn out to be.
…who claims to be able to forecast trend growth accurately and reliably. Even after the fact, it takes some time to discern the underlying trend. As a result, we need to build decision frameworks–for businesses and for policymakers–that are robust to the sorts of forecast errors we have seen in the past. Consider that approach the economist’s version of Keats’ negative capability. Second, our inability to get a precise fix on the output gap presents significant challenges for monetary policy, as this is commonly used as a prime indicator of inflationary pressures in the economy. If central bankers are unsure of the size of the output gap (or even its sign), then the likelihood of policy errors rises substantially. That reinforces the view of monetary policy setting as a problem of risk management in which policymakers must balance the hazards and costs associated with potentially large errors.”
Second, I think that the most important macroeconomic research question of our age is the extent to which these fluctuations in the projected growth path arise because of signal-processing considerations in an environment in which the growth rate is subject to both transitory and permanent shocks, rather than to short-run shocks casting very long-run shadows. To the extent that it is the second–and the older I get the more it looks to me as though it might well be–the more it becomes the case that successful management of aggregate demand and the business cycle is the ball game, rather than just being an amuse bouche that it is nice to have.
Third, there is the question that I now harp upon incessantly of the relationship between measured real GDP and money-metric utility in a consumer-surplus sense. (Plus there is the question of the relationship between money-metric utility in a consumer surplus sense and societal well-being.)
Fourth, I question whether previous pre-1980 studies of the U.S. economy would reveal similar fluctuations in trend growth projections. In fact, as best as I can determine, it does not. Going back to the start of the 1890s, at least, and even with such enormous shocks as the Great Depression and World War II, straightforward projections of real GDP do not fluctuate nearly as much as those that have been made over the last twenty years:
We had good news about long-run growth between 1955 and 1970, bad news between 1970 and 1985 that more-or-less returned us to the state of things as of 1955, essentially no net news between 1985 and 2000–and now really bad economic growth news since 2000.
Is this an illusion? Accidental overlapping and offsetting shocks that just happened to sum to zero? It may well be. Certainly output per potential worker grew very slowly as the baby boomers entered the labor force. On the other hand, to have naively projected that a decline in the growth of productivity associated with the entry of an enormous wave of workers with experience far below average would be permanent would seem naive.
And, of course, other countries did not exhibit that same stability in 1929-2000 or 1890-2000 real GDP growth rates. Of course, other countries also suffered wars and revolutions…