Morning Must-Read: Stephen G. Cecchetti and Kermit L. Schoenholtz: Forecasting Trend Growth: Living with Uncertainty
I draw somewhat different conclusions from the wavering track of potential GDP than do the vires illustres Steve Cecchetti and Kermit Schoenholtz. But let me reserve that until some moment later on in the day when I am more awake…
…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.