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July 10, 2014

Introducing the Atlanta Fed's GDPNow Forecasting Model

The June 18 statement from the Federal Open Market Committee opened with this (emphasis mine):

Information received since the Federal Open Market Committee met in April indicates that growth in economic activity has rebounded in recent months.... Household spending appears to be rising moderately and business fixed investment resumed its advance, while the recovery in the housing sector remained slow. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing.

I highlighted the business fixed investment (BFI) part of that passage because it contracted at an annual rate of 1.2 percent in the first quarter of 2014. Any substantial turnaround in growth in gross domestic product (GDP) from its dismal first-quarter pace would seem to require that BFI did in fact resume its advance through the second quarter.

We won't get an official read on BFI—or on real GDP growth and all of its other components—until July 30, when the U.S. Bureau of Economic Analysis (BEA) releases its advance (or first) GDP estimates for the second quarter of 2014. But that doesn't mean we are completely in the dark on what is happening in real time. We have enough data in hand to make an informed statistical guess on what that July 30 number might tell us.

The BEA's data-construction machinery for estimating GDP is laid out in considerable detail in its NIPA Handbook. Roughly 70 percent of the advance GDP release is based on source data from government agencies and other data providers that are available prior to the BEA official release. This information provides the basis for what have become known as "nowcasts" of GDP and its major subcomponents—essentially, real-time forecasts of the official numbers the BEA is likely to deliver.

Many nowcast variants are available to the public: the Wall Street Journal Economic Forecasting Survey, the Philadelphia Fed Survey of Professional Forecasters, and the CNBC Rapid Update, for example. In addition, a variety of proprietary nowcasts are available to subscribers, including Aspen Publishers' Blue Chip Publications, Macroeconomic Advisers GDP Tracking, and Moody's Analytics high-frequency model.

With this macroblog post, we introduce the Federal Reserve Bank of Atlanta's own nowcasting model, which we call GDPNow.

GDPNow will provide nowcasts of GDP and its subcomponents on a regularly updated basis. These nowcasts will be available on the pages of the Atlanta Fed's Center for Quantitative Economic Research (CQER).

A few important notes about GDPNow:

  • The GDPNow model forecasts are nonjudgmental, meaning that the forecasts are taken directly from the underlying statistical model. (These are not official forecasts of either the Atlanta Fed or its president, Dennis Lockhart.)
  • Because nowcasts are often based on both modeling and judgment, there is no reason to expect that GDPNow will agree with alternative forecasts. And we do not intend to present GDPNow as superior to those alternatives. Different approaches have their pluses and minuses. An advantage of our approach is that, because it is nonjudgmental, our methodology is easily replicable. But it is always wise to avoid reliance on a single model or source of information.
  • GDPNow forecasts are subject to error, sometimes substantial. Internally, we've regularly produced nowcasts from the GDPNow model since introducing an earlier version of it in an October 2011 macroblog post. A real-time track record for the model nowcasts just before the BEA's advance GDP release is available on the CQER GDPNow webpage, and will be updated on a regular basis to help users make informed decisions about the use of this tool.

So, with that in hand, does it appear that BFI in fact "resumed its advance" last quarter? The table below shows the current GDPNow forecasts:


We will update the nowcast five to six times each month following the releases of certain key economic indicators listed in the frequently asked questions. Look for the next GDPNow update on July 15, with the release of the retail trade and business inventory reports.

If you want to dig deeper, the GDPNow page includes downloadable charts and tables as well as numerical details including the model's nowcasts for GDP, its subcomponents, and how the subcomponent nowcasts are built up from both the underlying source data and the model parameters. This working paper supplies the model's technical documentation. We hope economy watchers find GDPNow to be a useful addition to their information sets.

Photo of Pat HigginsBy Pat Higgins, a senior economist in the Atlanta Fed's research department


July 10, 2014 in Data Releases, Economic Growth and Development, Forecasts, GDP | Permalink

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October 03, 2013

Why No Taper? One Man's View

Martin Feldstein will give you three possible reasons why—to some surprise, I gather—the Federal Open Market Committee (FOMC) decided two weeks back to not adjust the pace of its asset purchases:

One possibility is that Bernanke and the other FOMC leaders… never intended to start tapering…

A second possible explanation is that Bernanke and other Fed leaders were indeed anticipating that they would begin tapering QE in September but were startled at how rapidly long-term rates had risen in response to their earlier statements…

The third scenario is that economic activity was clearly slowing, with the future pace of activity therefore vulnerable to even higher interest rates.

Speaking only for myself, I choose Feldstein's third option. He goes a good way to making the case himself:

The annualized GDP growth rate in the first half of 2013 was just 1.8%, and final sales were up by only 1.2%. Although there are no official GDP estimates for the third quarter, private-sector assessments anticipate no acceleration in growth, putting the economy on a path that will keep this year's output gain at well under 2%.

That unfortunate story was pretty clear on the eve of the FOMC meeting—in particular, the lack of evidence that growth in the second half of the year would be an improvement on the already disappointing pace of the first half. Our own internal "nowcast" tracking model was suggesting third-quarter GDP growth in the neighborhood of the sub-2 percent growth that Feldstein cites. And as this table shows, things have not improved since:

131003_e

These facts, of course, were reflected in the downgrade of the 2013 growth forecasts published in FOMC participants' Summary of Economic Projections. But that is not all, as Professor Feldstein reports:

In addition, the Fed's preferred measure of inflation was much lower than its 2% target. The annual price index for personal consumer expenditure, excluding food and energy, has been rising for several months at a rate of just 1.2%, increasing the possibility of a slide into deflation.

And even if you don't go in for inflation measures that exclude food and energy, it doesn't much matter, because all-in inflation was, and still is, also running well below that 2 percent target:

131003_a

Though the August personal consumption expenditures price report finally provided a slight uptick in year-over-year core inflation, there was not even that scant hint of a return to the 2 percent inflation target by FOMC meeting time.

And that was looking a lot like strike number two to me. As Fed Chairman Ben Bernanke explained at the post-meeting press conference, repeating the criteria for adjustments to the FOMC asset purchase program that he laid out in June:

We have a three-part baseline projection which involves increasing growth…, continuing gains in the labor market, and inflation moving back towards objective… we'll be looking to see if the data confirm that basic outlook.

Of the remaining element of the three-part baseline, it is true that 12-month average monthly job gains looked pretty much like they did in June, when the talk of taper got serious:

131003_b

But the momentum—which I measure here as the ratio of three-month average monthly job gains to the 12-month average—was clearly in the downward direction:

131003_c

What's more, the revisions in prior months' employment statistics were running in the wrong direction:

131003_d

As a rule, forecasters don't sweat being wrong. That comes with the territory. But when you are persistently wrong in the same direction, it is time to worry at least a bit.

So, what do we have, then?

  • Inflation is low relative to the FOMC's objective—and has not moved in the direction of that objective with any conviction.
  • GDP growth has disappointed, with the anticipated pickup in second-half growth nowhere in sight.
  • "Continuing gains in the labor market" at the pace seen earlier in the year are looking a little shaky.

I find it pretty easy to see how this fails to add up to satisfaction of the three-part economic conditionality laid out in June by the Chairman (on behalf of the FOMC).

One could argue, I suppose, that the FOMC's explicit tying of asset purchases to improvement in the labor market makes it first among equals in the three-part test (as long as inflation is relatively stable), that similar downward momentum on the job front arose and disappeared in the summer of 2012, and that with a little patience things will appear on track.

Maybe. But I would point out that the reversal of negative momentum in the labor market the summer before was accompanied by the initiation of "QE3" (or at least the MBS part of QE3). You can draw your own conclusions about causality, but there is a fairly convincing case to be made for the proposition that, with the data in hand at the time, a wait-and-see decision was what patience dictated.

That, of course, begs the main question posed in Feldstein's article: When will it be time to taper? On that, and in the spirit of baseball playoff season, get your scorecard here

David Altig By Dave Altig, executive vice president and research director at the Atlanta Fed

October 3, 2013 in Federal Reserve and Monetary Policy, GDP | Permalink

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August 30, 2013

Still Waiting for Takeoff...

On Thursday, we got a revised look at the economy’s growth rate in the second quarter. While the 2.5 percent annualized rate was a significant upward revision from the preliminary estimate, it comes off a mere 1.1 percent growth rate in the first quarter. That combines for a subpar first-half growth rate of 1.8 percent. OK, it’s growth, but not as strong as one would expect for a U.S. expansion and clearly a disappointment to the many forecasters who had once (again) expected this to be the year the U.S. economy shakes itself out of the doldrums.

Now, we’re not blind optimists when it comes to the record of economic forecasts. We know well that the evidence says you shouldn’t get overly confident in your favorite economists’ prediction. Most visions of the economy’s future have proven to be blurry at best.

Still, we at the Atlanta Fed want to know how to best interpret this upward revision to the second-quarter growth estimate and how it affects our president’s baseline forecast “for a pickup in real GDP growth over the balance of 2013, with a further step-up in economic activity as we move into 2014.”

What we can say about the report is that the revised second-quarter growth estimate is a decided improvement from the first quarter and a modest bump up from the recent four-quarter growth trend (1.6 percent). And there are some positive indicators within the GDP components. For example, real exports posted a strong turnaround last quarter, presumably benefiting from Europe’s emerging from its recession. And the negative influence of government spending cuts, while still evident in the data, was much smaller than during the previous two quarters.  Oh, and business investment spending improved between the first and second quarters.

All good, but these data simply give us a better fix on where we were in the second quarter, not necessarily a good signal of where we are headed. To that we turn to our “nowcast” estimate for the third quarter based on the incoming monthly data (the evolution of which is shown in the table below).

A "nowcasting" exercise generates quarterly GDP estimates in real time. The technical details of this exercise are described here, but the idea is fairly simple. We use incoming data on 100-plus economic series to forecast 12 components of GDP for the current quarter. We then aggregate those forecasts of GDP components to get a current-quarter estimate of overall GDP growth.

We caution that unlike others, our nowcast involves no interpretation whatsoever of these data. In what is purely a statistical exercise, we let the data do all the speaking for themselves.

Given the first data point of July—the July jobs report—the nowcast for the third quarter was pretty bleak (1.1 percent). Things improved a few days later with the release of strong international trade data for June, and stepped up further with the June wholesale trade report. But the remainder of the recent data point to a third-quarter growth rate that is very close to the lackluster performance of the first half.


In his speech a few weeks ago, President Dennis Lockhart indicated what he was looking for as drivers for stronger growth in the second half of this year.

“I expect consumer activity to strengthen.”

Today’s read on real personal consumption expenditures (PCE) probably isn’t bolstering confidence in that view. Real PCE was virtually flat in July, undermining private forecasters’ expectation of a moderate gain. Our nowcast for real GDP slipped down 0.5 percentage points to 1.4 percent on the basis of this data, and pegged consumer spending at 1.7 percent for Q3—in line with Q2’s 1.8 percent gain.

“I expect business investment to accelerate somewhat.”

The July data were pretty disappointing on this score. The durable-goods numbers released a few days ago were quite weak, causing our nowcast, and those of the others we follow, to revise down the third-quarter growth estimate.

“I expect the rebound we have seen in the housing sector to continue.”

Check. Our nowcast wasn’t affected much by the housing starts data, but the existing sales numbers produced a positive boost to the estimate. Our nowcast’s estimate of residential investment growth in the third quarter is well under what we saw in the second quarter. But at 5.3 percent, the rebound looks to be continuing.

“I expect the recent improvement in exports to last.”

Unfortunately, the July trade numbers don’t get reported until next week. So we’re going to mark this one as missing in action.  But as we said earlier, that June trade number was strong enough to cause our third-quarter nowcast to be revised up a bit.

“And I expect to see an easing of the public-sector spending drag at the federal, state, and local levels.”

Again, check. The July Treasury data indicated growth in government spending overall.

So the July data are a mixed bag: some positives, some disappointments, and some missing-in-actions. But if President Lockhart were to ask us (and something tells us he just might), we’re likely to say that on the basis of the July indicators, the “pickup in real GDP growth over the balance of 2013” isn’t yet very evident in the data.

This news isn’t likely to come as a big surprise to him. Again, here’s what he said publicly two weeks ago:

When I weigh the balance of risks around the medium-term outlook I laid out, I have some concerns about the potential for ambiguous or disappointing data. I also think that it is important to be realistic about the degree to which we are likely to have clarity in the near term about the direction of the economy. Both the quantity of information and the strength of the signal conveyed by the data will likely be limited. As of September, the FOMC will have in hand one more employment report, two reports on inflation, a revision to the second-quarter GDP data, and preliminary incoming signals about growth in the third quarter. I don't expect to have enough data to be sure of my outlook.

It’s still a little early to say with any confidence we won’t eventually see a pickup this quarter, and we can hope that the incoming August numbers show a more marked improvement. All we can say at this point is that after seeing most of the July data, it still feels like we’re stuck on the tarmac.

Photo of Mike BryanBy Mike Bryan, vice president and senior economist,

Photo of Patrick HigginsPatrick Higgins, senior economist, and

Photo of Brent MeyerBrent Meyer, economist, all in the Atlanta Fed's research department


August 30, 2013 in Data Releases, Economic Growth and Development, Economics, Forecasts, GDP | Permalink

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August 16, 2013

GDP, Jobs, and Growth Accounting

The latest on productivity, from the Associated Press via USA Today:

U.S. worker productivity accelerated to a still-modest 0.9% annual pace between April and June after dropping the previous quarter.

The second-quarter gain...reversed a decline in the January-March quarter, when the Labor Department's revised numbers show productivity shrank at a 1.7% annual pace.

Labor costs rose at a 1.4% annual pace from April through June, reversing a revised 4.2% drop the previous quarter.

Productivity measures output per hour of work. Weak productivity suggests that companies may have to hire because they can't squeeze more work from their existing employees....

Productivity growth has been weaker recently, rising 1.5% in 2012 and 0.5% in 2011.

Annual productivity growth averaged 3.2% in 2009 and 3.3% in 2010. In records dating back to 1947, it's been about 2%.

Though not quite in the category of spectacular—and coming off revisions that if anything made things look weaker than previously thought—last quarter's uptick is a welcome development. Earlier this week, in a speech to the Atlanta Kiwanis club, Atlanta Fed President Dennis Lockhart laid out several scenarios with materially different implications for how the GDP and employment picture might play out over the next several years:

As a matter of arithmetic, healthy employment growth coupled with tepid GDP growth implies weak labor productivity growth. And in fact, productivity growth in recent quarters has been significantly below historical norms.

[I] believe that the recent low growth of productivity is probably just a temporary downdraft after the rather strong productivity growth when the economy emerged from recession.

If productivity growth rebounds to more typical levels, the coincidence of job gains at a pace of around 190,000 per month in recent months and GDP growth below 2 percent cannot persist. Again, it's a matter of arithmetic. Either GDP growth will rise to levels consistent with recent employment growth, or employment growth will fall to levels more consistent with the weak GDP data we've been witnessing.

I've got a working assumption on this question, and it is captured in the Atlanta Fed's baseline forecast for the second half of this year and 2014. This outlook calls for a pickup in real GDP growth over the balance of 2013, with a further step-up in economic activity as we move into 2014.

You can get a sense of this outlook by considering the output of one particular model that we use here at the Atlanta Fed. The model, which is purely statistical, gives us a view into how productivity, GDP, employment, and the unemployment rate might move together (along with other labor market variables like labor force participation and average hours worked). Here is the bottom line of an exercise that assumes GDP growth through 2015 comes in at about the central tendency of the projections from the Federal Reserve's June 2013 Summary of Economic Projections.

For this exercise, we have adjusted the 2013 growth forecast down slightly due to the weaker-than-expected growth in the first half of the year. Additionally, we have plugged in assumptions for productivity growth—1.5 percent per quarter (SAAR), the average gain over the past eight years—and nonfarm business output growth. We then let the model forecast the remaining variables, all of which are for the labor market:

130816a

The model forecasts employment gains in the neighborhood of what the economy has been generating over the past several years, and a steadily declining unemployment rate.

Now consider two "stall" scenarios in which GDP growth fails to get beyond 2.3 percent. The first of these scenarios is the one noted in the Lockhart Kiwanis speech, with productivity recovering but job growth falling off the pace:

130816b

From a policy perspective, this one may not cause too much handwringing about the appropriate course of action. The weak GDP growth is accompanied by a failure to make the type of progress on the unemployment rate that the FOMC has clearly articulated as the necessary condition for adjustments in policy rates:

[T]he Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

Absent unforeseen issues with inflation, staying the course would seem to be in order.

But there is a second stall scenario in which productivity and GDP growth remain tepid, even as labor market indicators improve:

130816c

The difference in this experiment is that the expectations of those that President Lockhart referred to in his speech as the "innovation pessimists" are correct. Recent weakness in productivity growth reflects a fall in trend productivity growth. In this case, essentially identical labor market outcomes would nonetheless correspond to an economy that can't seem to hit "escape" velocity.

If it is clear that this configuration of outcomes is associated with a structural break in productivity growth, an argument against monetary policy stimulus would have some weight. After all, in most cases we don't expect the tools of monetary policy to fix structural efficiency problems.

But, alas, such clarity rarely arrives in real time. The experiments above give some sense of how difficult it can be to discover the right branch to follow on the policy decision tree.

Photo of Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed


August 16, 2013 in Data Releases, Employment, GDP, Labor Markets, Productivity, Unemployment | Permalink

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The fundamental challenge with income statistics is that we are being confused by the terrible impact of a completely left tailed incomes distribution prior to the crisis with a job growth that is happening at the bottom of the pyramid, which effectively means that even though the job numbers look good, its impact on the GDP growth would be minuscule.

Posted by: Procyon Mukherjee | August 17, 2013 at 07:01 AM

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June 25, 2013

Getting Back to Normal?

Central to any discussion about monetary policy is the degree to which the economy is underperforming relative to its potential, or in more ordinary language, how much slack exists. OK, so how much slack is there, and how long will it take to be absorbed? Well, if you ask the Congressional Budget Office (and a lot of people do), they would have told you last February (their latest estimate) that the economy was underperforming just a shade more than 4 percent relative to its potential last summer, and that slack was likely to increase a little by this summer (to around 4.7 percent). Go to the International Monetary Fund (IMF), and they tell a very similar story in their April World Economic Outlook. The IMF estimates that the amount of slack in the U.S. economy was about 4.2 percent last year, and they expected it would rise a little to about 4.4 percent this year.

As devotees of our Business Inflation Expectations survey know (and you know who you are), the Atlanta Fed has a quarterly, subjective measure of economic slack in the economy as seen by business leaders. This month, businesses told us something pretty interesting—the amount of slack they think they have narrowed pretty sharply between March and June.

Last March, the panel told us that their unit sales were 7.7 percent below "normal"—similar to their assessments in December and September. This month, however, the group cut their estimate of slack to 4.3 percent below normal, on average (see the table).

130625a

What we find most encouraging about this assessment (well, besides the speed at which the slack was being taken up) is that the improvement was most prominent among small and medium-sized firms. These are firms that, according to our survey and other reports (like this one from the National Federation of Independent Business), have been lagging behind in the recovery. Indeed, in June, mid-sized firms indicated that unit sales were only 1.5 percent below normal, a shade better than the big firms in our panel (see the table).

130625b

A look at the industry composition of our survey reveals that the pickup of slack was relatively broadly based too. Only the firms in the mining and utilities, and the professional and business services areas reported more slack relative to March (and the amounts were pretty small at that). Elsewhere, the amount of slack appears to have narrowed quite a bit.

OK, so slack is shrinking, and according to these estimates, it shrank quite a bit between March and June. Does that mean we should be anticipating growing price pressure? Well, we can turn to our panelists again for an answer, and they say no. Projecting over the year ahead, our panelists report little change in either their inflationary sentiment or their inflation uncertainty (see the table).

130625c

Last Wednesday, at the conclusion of its June meeting, the Federal Open Market Committee said that the recovery is proceeding and the labor market is improving, but inflation expectations remain stable. Our June poll of business leaders appears to have also endorsed this view of the economy.

Photo of Mike BryanBy Mike Bryan, vice president and senior economist,

Photo of Brent MeyerBrent Meyer, economist, and

Photo of Nicholas ParkerNicholas Parker, senior economic research analyst, all in the Atlanta Fed's research department

 

June 25, 2013 in Business Inflation Expectations, Federal Reserve and Monetary Policy, GDP, Inflation, Inflation Expectations | Permalink

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February 22, 2013

Nature Abhors an Output Gap

In The Washington Post, Neil Irwin highlights a shortcoming that I know all too well:

Throughout the halting economic recovery that began in 2009, the formal economic projections released by the Congressional Budget Office, White House Council of Economic Advisers, and Federal Reserve have displayed quite a consistent pattern: This year may be one of sluggish growth, they acknowledge. But stronger growth, of perhaps 3.5 percent, is just around the corner, and will arrive next year.

Consider, for example, the Fed's projections in November of 2009. Sure, growth would be slow in 2010, they held. But 2011 growth, they expected, would be 3.4 to 4.5 percent, and 2012 would 3.5 to 4.8 percent growth. The actual levels of growth were 2 percent in 2011 and 1.5 percent in 2012.

What's amazing is that the Fed's newest projections, released in December of 2012, look like they could have been copy and pasted from 2009, just with the years changed: They forecast sluggish growth in 2013, 2.3 to 3 percent, followed by a pickup to 3 to 3.5 percent in 2014 and 3 to 3.7 percent in 2015.

I, for one, am guilty as charged, and feel pretty fortunate that the offense is not a hanging one. In fact I don't think Irwin's indictment is overly harsh, and he is on the right track when he offers up this explanation for the last several years' persistently overly rosy projections:

Economic forecasters tend to look at past experience and extrapolate; in the past, when there has been a recession, the very forces that caused the recession become unwound, sowing the seeds for expansion...

Here is a basic fact about macroeconomic forecasting. The truly powerful driver of forecasts is mean reversion, which is the tendency of models to predict that gross domestic product (GDP) will move toward an average trend over time. This fact holds true whether we are talking about formal statistical analysis or the intuitive judgmental adjustments that all forecasters apply to their formal statistical models.

Forecasters are not completely robotic, of course. Irwin is correct when he says "forecasters tend to look at past experience and extrapolate, but forecasters do leaven past experience with incoming details that alter judgments about what is the mean—the "normal state," if you will—to which the economy will converge. But whatever is that normal state, our models insist that we will converge to it.

Nothing illustrates this property of forecasting reality better than this chart, which supplements the latest economic projections from the Congressional Budget Office:

130222a


The potential GDP line in that chart is the level of production that represents the structural path of the economy. Forecasters, no matter where they think that potential GDP line might be, all believe actual GDP will eventually move back to it. "Output gaps"—the shaded area representing the cumulative miss of actual GDP relative to its potential—simply won't last forever. And if that means GDP growth has to accelerate in the future (as it does when GDP today is below its potential)—well, that's just the way it is.

Unfortunately, potential GDP is not so simple to divine. We have to guess (or, more generously, estimate) what it is. That guessing game has been harder than usual over the past several years. Here is the record of the CBO's potential GDP since 2009:

130222b


I think this picture is a fairly representative record of how views about the potential level of U.S. GDP has evolved over the past several years. What has not been resolved is the debate over what conclusions should be drawn from persistent overestimates of potential and serial misses to the high side on GDP projections.

Irwin seems to be of two minds. On the one hand he offers very structural-sounding reasons for poor forecasting experience:

... the financial-crisis-induced recession of 2008–2009 was so deep that it had deep-seated effects that go beyond those explained by those traditional relationships. It messed up the workings of the financial system, and banks are still trying to figure out what the new one looks like.

On the other hand, he makes appeals to very traditional explanations tied to deficient spending and insufficient policy stimulus (though even here structural change may be one reason that stimulus has been insufficient):

Breakdowns in the financial system mean that low-interest rate policies from the Fed don't have their usual punch. An overhang of household debt means that consumers hold their wallets more than usual. Federal fiscal stimulus to offset those effects is now long-over...

This much, in any event, is clear: Given any starting point where the level of GDP is below its potential level—that is, given an output gap—forecasts will include a bounce back in GDP growth above its long-run average, at least for a while. That's just the way it works.

If, contrary to conventional wisdom, you believe that the true output gaps are much smaller than suggested in the CBO picture above, you might want to take the under on a bet to whether GDP forecasts will prove too optimistic once again.

Photo of Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed

 

February 22, 2013 in Forecasts, GDP | Permalink

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Dave - I generally enjoy your posts, but I am surprised that in this one you pretty much ignored the single biggest...and unresolved...question about econometric modeling in this case. You (not just you, of course, but lots of modelers) assume that GDP is trend-stationary rather than unit root. But the history of the last few years is MUCH easier to describe as 'failing to reject the hypothesis' that GDP growth is unit root, wouldn't you say?

I wrote something about this a couple of years ago to explain the issue to non-economists: https://mikeashton.wordpress.com/2010/10/12/the-root-of-the-problem/

Anyway, otherwise I like your articles. Thanks.

Posted by: Michael Ashton | February 22, 2013 at 08:45 PM

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January 18, 2013

Still a Skeptic: Addressing a Few Questions about Nominal GDP Targeting

In a comment to last week's post on inflation versus price-level targeting, David Beckworth asks the following (referring back to an even earlier post on nominal gross domestic product [NGDP] targeting):

You refer back to your previous post on NGDP level targeting, but fail to take note of the comments that respond to your concerns about it. Specifically, see the ones by Andy Harless and Gregor Bush. Would love to see your response to those ones. Do you have a response for them? I am listening if you have one.

Here is an excerpt from the Harless comment...

Most people who advocate NGDP targeting today advocate level path targeting, not growth rate targeting. I don't believe that your "historical justification" applies in this case. Indeed, I think it makes the case for level targeting (of either the price level or NGDP, but there are reasons to prefer the latter) relative to the current system which centers on a growth rate target for the price level (in other words, an inflation target).

...and here is the Bush comment:

Just to add to Andy's point, advocates of NGDP level targeting argue that it's precisely because of uncertainty around estimates [of] potential output [that] NGDP targeting should be adopted. They argue that [as] long as the central bank keeps nominal spending on, say, a 5% trend line, there will be neither demand side recessions (mass unemployment) nor high inflation. In other words, AD will be stable and this will produce a stable macroeconomic environment. Whether inflation is 2% and real output [grows] at 3% or inflation is 3% and real output grows at 2% is of no concern.

In the post on NGDP targeting I was in fact thinking about level targeting, and Gregor Bush's last sentence gets to—in fact is—the heart of our disagreement. I am just not willing to concede that anchoring long-term inflation by saying something like "2 percent, 3 percent, whatever" is the path to sustaining central bank credibility. Over the longer term, inflation is the only thing that monetary policy can reliably deliver, as the Federal Open Market Committee (FOMC) has clearly articulated in its statement of longer-run goals and policy strategy:

The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate...

The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision.

This excerpt does not imply, of course, that the Fed need slavishly pursue a numerical inflation target in the shorter run and, as I have pointed out before, in his last press conference Chairman Bernanke explicitly indicated that the FOMC does not intend to do so:

The Committee... intends to look through purely transitory fluctuations in inflation, such as those induced by short-term variations in the prices of internationally traded commodities, and to focus instead on the underlying inflation trend.

My price-level targeting post, co-authored with Mike Bryan, was exactly making the point that, over the past couple of decades, the FOMC has essentially delivered on a 2 percent longer-term price-level growth objective, while accepting plenty of shorter-term variability.

In the end, it is an open question whether credibility in delivering price stability, hard won in the '80s and early '90s, could be sustained if the FOMC says it does not care so much about the exact level of the average rate of inflation, even in the long run. To be truthful, I can't give you an answer to that question. But neither can the proponents of NGDP targeting. I just don't feel that this is an opportune time for an experiment.

Update: Scott Sumner responds.

Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed

 

January 18, 2013 in Federal Reserve and Monetary Policy, GDP, Monetary Policy | Permalink

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"I am just not willing to concede that anchoring long-term inflation by saying something like "2 percent, 3 percent, whatever" is the path to sustaining central bank credibility. Over the longer term, inflation is the only thing that monetary policy can reliably deliver, as the Federal Open Market Committee (FOMC) has clearly articulated in its statement of longer-run goals and policy strategy:..."

Presumably the damning part of the FOMC statement is the following portion:

"...The maximum level of employment is largely determined by nonmonetary factors that affect the structure and dynamics of the labor market. These factors may change over time and may not be directly measurable. Consequently, it would not be appropriate to specify a fixed goal for employment; rather, the Committee's policy decisions must be informed by assessments of the maximum level of employment, recognizing that such assessments are necessarily uncertain and subject to revision..."

This might be relevant if nominal GDP (NGDP) level targeting were indeed "specifying a fixed goal for employment." But NGDP level targeting is not specifying a fixed goal for employment. Rather it is specifying a fixed goal for NGDP.

The only thing that the Fed can reliably target are nominal variables, such as inflation and NGDP.

But one very significant problem with targeting inflation is that it is a totally artificial construct requiring that we come up with an estimate of the extraordinary abstraction known as the "aggregate price level." To see how preposterous this is imagine equating the aggregate price level between what it is now and what it was in say 14th century England. The goods and services are so different it requires the complete suspension of one's disbelief.

Inflation is the difference between NGDP and real GDP (RGDP), meaning inflation is nothing more than the estimated residual between a nominal variable, which is relatively straight forward to measure, and a real variable, which is fundamentally an exercise in crude approximation.

In short, this is precisely backwards.

Posted by: Mark A. Sadowski | January 19, 2013 at 12:42 PM

Thanks David,
I appreciate your response. I have to disagree with this statement though:

“I am just not willing to concede that anchoring long-term inflation by saying something like "2 percent, 3 percent, whatever" is the path to sustaining central bank credibility. Over the longer term, inflation is the only thing that monetary policy can reliably deliver, as the Federal Open Market Committee (FOMC) has clearly articulated in its statement of longer-run goals and policy strategy.”

I don’t think that’s correct. It’s true that monetary policy can’t target real variables in the long run. But it can certainly target any nominal variable that it wants to. The Hong Kong Monetary authority has targeted an exchange rate of 7.75 HKD per USD for almost 30 years and it has been completely successful in doing so. Inflation over that period of time has fluctuated substantially, reaching a high of +12% in 1991 to a low of -6% in 1999. Over that 30 year period, Hong Kong inflation has averaged about 1.3 percentage points above US inflation. Does all of this mean that the HKMA has no credibility? Of course not. It has been and continues to be completely credible with respect to the chosen target. Now, we could argue whether Hong Kong might be better severed if it targeted 2% CPI inflation rather than the nominal USD exchange rate (I think it would be). But that’s an argument over which comes closer to the socially optimal target, not over which target would give the central bank more credibility.

We could make a similar argue with the Bank of England successfully targeting the nominal price of gold in the 1871 to the 1914 period. So I see no reason why the Fed couldn’t target nominal GDP and be completely credible with respect to its NGDP target. If Congress instructed the Fed to switch to an NGDP level target would you bet against the FOMC hitting it?

“I just don't feel that this is an opportune time for an experiment.”

Here again, I disagree. I think it’s an excellent time. The only better time would have been January of 2009. The performance of the economy over the past 5 years has been an unmitigated disaster. And the “hard won battles” of the early 1980s and 1990s weren’t enough to prevent it. It turns out that anchoring inflation expectations at 2% is not enough to prevent a massive and sustained shortfall in aggregate demand. In 2007, I thought that a 2% inflation target ruled out the possibility of a recession of this magnitude. But I was wrong.

Posted by: Gregor Bush | January 21, 2013 at 04:56 PM

Thanks David for taking the time to reply. I have been meaning to respond, but as you note Scott already has. I would also encourage you to take a look at Scott's piece in the FT Alphaville where he engages in a similar discussion:

http://ftalphaville.ft.com/2013/01/24/1353932/guest-post-scott-sumner-responds-on-ngdp-level-targeting/

Also, see Bill Woolsey's response to Charles Goodhart's NGDPLT critique:

http://monetaryfreedom-billwoolsey.blogspot.com/2013/01/goodhart-on-ngdplt.html

Posted by: David Beckworth | January 24, 2013 at 10:22 AM

I am fully convinced that the Fed policy and tac is incorrect. 0% interest rates and continuous monetization of the debt through QE is not getting us anywhere.

There are opportunity costs as well.

I realize the fiscal policy which the Fed doesn't control isn't optimum either. But, the Fed ought to let the charade stop.

Posted by: Jeff Carter | January 30, 2013 at 10:13 PM

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December 28, 2012

Nominal GDP Targeting: Still a Skeptic

In a few days the clock will run out on another year of disappointing economic growth in the United States and, generally speaking, in the world. It is inevitable and appropriate, then, that the year-end ritual of looking forward by looking backward will include an assessment of whether more or better policy can contribute to a pick-up in growth that failed to materialize in 2012.

To this discussion, Harvard professor Jeff Frankel brings some fresh thinking to the not-quite-fresh notion that the Fed should adopt a nominal gross domestic product (GDP) targeting approach as a replacement for existing central bank practice—described by Frankel and others as policy driven by an inflation-targeting framework. What I particularly like about Frankel's proposal is the fact that he offers up a practical roadmap for using the Fed's current communications tools to transition to an explicit nominal GDP targeting framework. If I were inclined to think such a move would be a good idea, I would view Frankel's proposal with some enthusiasm. Alas, I am not yet so inclined.

As to the case for skepticism on theoretical grounds, I commend to you this excellent post by Mark Thoma at Economist's View. But Professor Frankel suggests a case for nominal GDP targeting on practical grounds by appealing to this counterfactual:

A nominal GDP target for the US Federal Reserve might have avoided the mistake of excessively easy monetary policy during 2004-06, a period when nominal GDP growth exceeded 6 per cent.

Maybe. Average annual real GDP growth over those three years was just over 3 percent, compared to the Congressional Budget Office (CBO) estimates of potential GDP growth of just under 2.5 percent. That's not a big difference, but more importantly the average gap between the level of real GDP and the CBO estimate of potential was just 0.3 percent of average output—essentially zero. The importance of this so-called "output gap" becomes evident if you read the Michael Woodford interview referenced in the aforementioned piece at Economist's View. In that interview, Woodford says, "The idea was to talk about a price level, as opposed to the inflation rate, but a corrected price level target where you add to it some multiple of the real output gap." So for him, something like this measure would be a key element of his proposed monetary policy rule.

What if, rather than some measure of nominal GDP, the 2004–06 Fed had instead been solely focused on the inflation rate? You can't answer that question without operationalizing what it means to be "focused on the inflation rate," but for the sake of argument let's simply consider actual annualized PCE inflation over a two-year horizon. (In his press statement explaining the Federal Open Market Committee's (FOMC) latest decision, Fed Chairman Ben Bernanke suggested using a one- to two-year horizon for inflation forecasting horizon to smooth through purely transitory influences on inflation that the central bank would inclined to "look through.") Here's the record, with the period from 2004 through 2006 highlighted:

121228b

If you really do think that there was a policy mistake over the 2004–06 period—and in particular if you believe the FOMC during that should have adopted a more restrictive policy stance—I'm hard-pressed to see what advantage is offered by focusing on nominal GDP rather than inflation alone. In fact, you could argue that that the GDP part of the nominal GDP target would have added just about nothing to the discussion.

I add the observation in the chart above to my earlier comments on an earlier Frankel call for nominal GDP targets. To summarize my concerns, the Achilles' heel of nominal GDP targeting is that it provides a poor nominal anchor in an environment in which there is great uncertainty about the path of potential real GDP. As I noted in my earlier post, there is historical justification for that concern.

Basically, anyone puzzling through how demographics are affecting labor force participation rates, how technology is changing the dynamics of job creation, or how policy might be altering labor supply should feel some humility about where potential GDP is headed. For me, a lack of confidence in the path of real GDP takes a lot of luster out of the idea of a nominal GDP target.

Dave AltigBy Dave Altig, executive vice president and research director at the Atlanta Fed

 


December 28, 2012 in Federal Reserve and Monetary Policy, GDP, Monetary Policy | Permalink

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I think you're right to be a skeptic on targeting NGDP. Nominal GDP bounced between 5-7% post the 2001 recession. And that's after all the revisions. Maybe more to the point is that the Great Recession occurred, in large part, because of hyper credit growth. It's likely that rates were kept too low for too long, which ultimately pushed the reach for yield process, which enabled the excess debt creation. We won't go into the abdication of the regulatory bodies.....

Posted by: stewart sprague | December 28, 2012 at 06:53 PM

Most people who advocate NGDP targeting today advocate level path targeting, not growth rate targeting. I don't believe that your "historical justification" applies in this case. Indeed, I think it makes the case for level targeting (of either the price level or NGDP, but there are reasons to prefer the latter) relative to the current system which centers on a growth rate target for the price level (in other words, an inflation target).

The question is whether the Fed should forgive itself for missing earlier targets. Under the current system, there is near-100% amnesty, which has the potential to make the nominal anchor ineffective, in the case where the Fed keeps making the same mistake over and over, as it did in the 1970's. A level path target during the 1970's would have forced the Fed to tighten when it missed its targets on the upside, in order to get back to the target path. This is true for either a price level path target or an NGDP level path target.

Of course the downside of using a level path target is pretty obvious: you need to produce "unnecessary" recessions and/or inflations to compensate for earlier misses. But I think the improvement in credibility (particularly when the zero bound comes into play, but also in a situation like the 1970's, where forecast errors were serially correlated) would be worth the cost. And I don't think there's much of a case to be made that price level path targeting is better than NGDP level path targeting, unless the price level is your only mandated objective.

Posted by: Andy Harless | December 28, 2012 at 07:21 PM

"To summarize my concerns, the Achilles' heel of nominal GDP targeting is that it provides a poor nominal anchor in an environment in which there is great uncertainty about the path of potential real GDP."

I think that most people who are blogging in support of NGDP level targeting would be puzzled by this comment. Yes, NGDP level targeting sets the nominal anchor in terms of nominal incomes, not the price level. But most of what are called "welfare costs of inflation" seem to correlate better with variations in nominal incomes than in prices. For instance, "natural" interest rates are better described as correlating with NGDP growth rates than with inflation rates; nominal wages correlate with NGDP rather than the price level.

George Selgin (in "Less than Zero") advances a rather complex argument that because variations in RGDP are generally due to firm- or sector-specific changes, nominal income targeting interacts better with price stickiness and similar imperfections.

In general, resiliency to supply-side instability is generally seen as a key _benefit_ of NGDPLT: and this should be all the more true when the RGDP path is uncertain.

Anyway, Sumner has come up with a 'compromise' proposal (dubbed a NGDP/inflation hybrid) which aims to stabilize NGDP in the short/medium run while still keeping a stable inflation target in the longer run: see www.themoneyillusion.com/?p=18145

Posted by: anon | December 29, 2012 at 10:13 PM

What matters for monetary policy is how it affects expectations. In that context, you're either missing or ignoring a couple of things about the Market Monetarist position.

First, a level target rather than a growth rate target really matters. The former is equivalent to the latter but with the additional assurance that misses will be made up for. That assurance means that over all but the shortest runs, the implicit growth rate target will be hit. That can only help when expectations are your real target.

In the Thoma post you link to, Woodford also points out that as a pratical matter, an NGPD level target is about the best the Fed can do. A policy rule has to (i) be simple enough that you can explain it to Congress and the public, and (ii) be straightforward enough that it doesn't arouse suspicions that the Fed is cooking the books. We have enough conspiracy theorists out there already. Let's not feed them even more by employing a target that looks like the Fed could be manipulating it via arcane calculations.

As you say, we don't know the future path of potential output. But that's hardly an excuse to add to the uncertainty by refusing to adopt clear and predictable Fed policies.

Posted by: Jeff | December 30, 2012 at 08:02 AM

Isn't there a point at which the policy stance should be to stop intervening in markets, to let the free market determine interest rates like any other price, and for the Fed to stop targeting ANYTHING? Why are we even entertaining never ending central planning as a solution to anything?

Posted by: Chris | January 01, 2013 at 09:49 PM

Isn't there a point at which the policy stance should be to stop intervening in markets, to let the free market determine interest rates like any other price, and for the Fed to stop targeting ANYTHING? Why are we even entertaining never ending central planning as a solution to anything?

Posted by: Chris | January 01, 2013 at 09:49 PM

David,
Just to add to Andy's point, advocates of NGDP level targeting argue that it's precisely becasue of uncertainty around estiamtes potential output is NGDP trageting should be adopted. They argue that has long as the central bank keeps nominal spending on, say, a 5% trend line, there will be niether demand side recessions (mass unemployment) nor high inflation. In other words AD will be stable and this will produce a stable macroeconomic environment. Whether inflation is 2% and real output growth at 3% or inflation is 3% and real output grows at 2% is of no concern.

Posted by: Gregor Bush | January 04, 2013 at 02:13 PM

Anybody here ever heard of Goodhart's Law?

Posted by: Thomas Esmond Knox | January 13, 2013 at 11:54 PM

Most people who advocate NGDP targeting today advocate level path targeting, not growth rate targeting

Posted by: myVegas hack cheats tool | February 07, 2013 at 03:15 PM

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August 17, 2012

The (Unfortunately?) Consistent Record of the Recovery

In his last two posts (here and here), economist Tim Duy has done some yeoman work displaying and discussing the economic context of monetary policy decisions past and prospective. Though Wednesday's self-titled post "Data Dump" focuses on the incoming data as a set-up to the next meeting of the Federal Open Market Committee (FOMC), what strikes me is the consistency of the broad macroeconomic outcomes over the course of the recovery. Gross domestic product (GDP) growth has pretty clearly clocked in at about 2 percent...


...and, looking through the quarterly ups and downs, payroll employment growth has clearly trended near 150,000 jobs per month after a slower start in 2010:


The inflation picture shows more variation...


...but in my view, that sort of variation is why it makes sense to think in terms of medium-term performance. "Medium-term" is more a measure of art than science, and I would concede the point that the recovery as a whole would be on the shorter end of that time frame. Suffice it to say that the pace of price-level growth over the past two and a half years wouldn't contradict the presumption that inflation is pretty close to the FOMC's stated longer-run objective.

Duy looks at this performance and sees pretty clear evidence of failure:

The economy continues to settle into a path that is not consistent with either part of the Fed's dual mandate. Moreover, there are very real downside risks to even a tepid outlook...

This is frustrating. What in the world is the point of making a big claim to affirm the nature of the dual mandate and then subsequently ignore any forecasts that indicate you have no faith the elements of the dual mandate will be met anytime soon?

That complaint is not really about the inflation part of the mandate, but the employment/growth part of it. But if you are willing to accept that employment growth remains on a pace of 150,000 jobs per month—and I see no clear evidence to the contrary—it is not at all obvious that the pace of the recovery is inconsistent with the FOMC's view of achieving its dual mandate. Here, for example, are the central tendency ranges of the unemployment rate projections from the FOMC's June Summary of Economic Projections (SEP) and the employment growth that would be required to meet those objectives (with some important assumptions, such as the labor force participation rate remaining at the current level).


Here is the important statement of conditionality, as described in the SEP document:

The charts show actual values and projections for three economic variables [GDP growth, the unemployment rate, and PCE inflation] based on FOMC participants' individual assessments of appropriate monetary policy.

Under appropriate policy—which pretty clearly means mandate-consistent outcomes—the majority of FOMC participants don't seem to think that the unemployment rate will improve that quickly. And, to my point, it is not clear that the trend in payroll employment is inconsistent with that pace of improvement.

Of course, individual contributors to the SEP may have different assumptions about things like the labor force participation rate. More importantly, the SEP is silent on what, in each contributor's view, constitutes "appropriate policy."

And I am certainly begging the important issues. Would the economy have achieved even the somewhat unspectacular pace of 2 percent GDP growth, 150,000 jobs per month, and average inflation near the long-run objective absent large-scale asset purchases ("QE2"), forward guidance (statements indicating that policy rates are expected to be exceptionally low through at least late 2014), and maturity extension programs ("Operation Twist")? Does "appropriate policy" imply that more must be done to achieve even the modest progress in the unemployment rate implied in my calculations above? And could we have (looking backward) or can we (looking forward) do even better with an even more aggressive approach, as many Fed critics argue?

Good questions, those.

David AltigBy Dave Altig, executive vice president and research director at the Atlanta Fed

 


August 17, 2012 in Employment, GDP, Inflation | Permalink

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July 23, 2012

How big is the output gap?

It's fair to say, I think, that the question posed in the title of this blog post is at the heart of any monetary policy debate.

Here's how the discussion went at the June meeting of the Federal Open Market Committee (FOMC):

"Meeting participants again discussed the extent of slack in labor markets. Some participants judged that the unemployment rate was being substantially boosted by structural factors such as mismatches between the skills of unemployed workers and those required for available jobs....One implication of the view that there is relatively little slack is that providing more monetary stimulus would be likely to raise inflation above the Committee's objective. Some other participants acknowledged that structural factors were contributing to unemployment, but said that, in their view, slack remained high and weak aggregate demand was the major reason that the unemployment rate was still elevated. These participants cited a range of evidence to support their judgment....These arguments imply that slack in labor markets remains considerable and therefore that a reduction in the unemployment rate toward its longer-run normal level would not have much effect on inflation."

If you want more specifics about these contrasting views, you might find recent speeches by some FOMC meeting participants helpful. Jeff Lacker, president of the Federal Reserve Bank of Richmond, is pretty clearly in the "relatively little slack" group:

"It's worth noting...that the effects of unemployment insurance benefits together with the effects of labor market inefficiencies could plausibly account for a quite substantial portion of our elevated unemployment rate. The quantitative estimates of labor market mismatch come from independent methods and datasets and, in principle, measure conceptually distinct inefficiencies. We shouldn't necessarily assume these effects are additive, but combining all three together yields a range of 2.9 to 5.9 percentage points, which is sizable relative to the increase in the total unemployment rate of 5-½ percentage points during the recession."

Vice Chairman Janet Yellen is also pretty clearly on the other side of the debate:

"A critical question for monetary policy is the extent to which these numbers reflect a shortfall from full employment versus a rise in structural unemployment. While the magnitude of structural unemployment is uncertain, I read the evidence as suggesting that the bulk of the rise during the recession was cyclical, not structural in nature.

"Consider...the difference between the actual unemployment rate and the Congressional Budget Office (CBO) estimate of the rate consistent with inflation remaining stable over time...[the] index of the difficulty households perceive in finding jobs...[and the] index of firms' ability to fill jobs....All three measures show similar cyclical movements over the past 20 years, and all now stand at very high levels."

The positions outlined above lay bare why estimates of the output gap command such weight in the discussion of monetary policy—both ends of the FOMC's dual mandate of maximum employment and price stability may run through it. If the output gap is large, that is, if the level of gross domestic product (GDP) is running significantly under potential GDP, the economy is obviously not in a position of maximum employment. And if that is the case, the inflation trend is likely to be headed lower and so the price stability mandate may also be in jeopardy.

Where do I come out in this debate? That isn't important since I don't get a vote. But my boss, Dennis Lockhart does, and he laid out his position in a recent speech to the Mississippi Economic Council.

"I think the output gap—the amount of slack in the economy—is neither as sizeable as the high-end estimates, nor is it zero. If there were no slack at all, 8.2 percent unemployment would represent full employment. If this were so, the economy would have undergone profound structural change over the last five years. As I weigh the findings of research by Federal Reserve economists and others, I do not think a compelling case has yet been made that structural adjustment has played a dominant role in slowing growth and progress against unemployment.

"If, on the other hand, slack in the economy were close to the high estimates, we should have seen more and more persistent downward pressure on prices and wages than has, in fact, been the case. Deciding on the extent of the output gap is not straightforward. I believe the truth is in the gray middle."

To emphasize, this "gray middle" isn't a compromise but a weighing of the available evidence. If the GDP gap really is close to zero, the profound structural change that the economy ought to have experienced hasn't found great support in the data. But if this is just a bigger version of gaps of recessions past, then where is the great disinflationary pressure such slack would ordinarily imply?

You may have another view and, again quoting Lockhart's recent speech, "reasonable people can consider the issues...and come to different conclusions. "And if you're having trouble getting a grasp on GDP, potential GDP, and why the measurement of our national potential isn't an easy task, perhaps we can help. We've recently produced an educational video on the issue. It's not a deep treatment of the issue—in fact, just the opposite. It's a jumping-in point for those who are interested in the policy debate but haven't a clue what a GDP gap is. As always, let us know what you think.

Mike Bryan By Mike Bryan, vice president and senior economist in the research department at the Atlanta Fed


July 23, 2012 in GDP | Permalink

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well, the size of the output gap is mostly beside the point: we *never*, never know the size of the output gap. We didn't in 2007. We didn't in 1998, nor did we know it 1976. Pick a year, we didn't know it that year either.

So whether we know the size of the gap or not should not be relevant, since we've never actually known it. Nor do we know the lags or leads with which monetary policy affects the economy (i say leads, because we know planners set expectations so policy acts with a lead).


The name of the game is not to pick a policy target that corresponds to the size of the output gap, an unknown. The name of the game is to pick a policy that we know will have desirable outcomes *regardless* of the size of the output gap.


Another fact we know is that most people learn on the job. Back in the 90s during the IT boom, most people entering IT did had other backgrounds. Employers in the US generally train employees (even if they have a grad degree). When demand for labor is high enough, employers cant be as picky as they are now. There is no such thing as "structural unemployment" only low demand for labor.


Third, we know that the Federal Reserve cannot target import prices without raising unemployment. 80% of the gap between PCE and GDP deflator is correlated with *oil prices.* You know, the housing market was well into recession in 2008, when the fed left rates at 2% in sept 2008, because it was overly focused on an inflation measure highly influenced by oil prices.

When you add all this up: unknown potential output, weak aggregate demand, and inappropriate measures of domestic inflation, it all adds up to failed policy.

A far better policy over the last 5 years would have been simple nominal income targeting. Had the Fed simply targeted a 4.5% growth path and agreed to steer the nominal economy along that path, we would be in far better shape regardless of the size of the output gap. So-called deleveraging would be proceeding as a far more rapid pace.


Posted by: dwb | July 24, 2012 at 08:28 AM

Precisely how would income targeting work? The Fed controls interest rates, not the aggregate money supply. It has tried monetary targeting, interest rate targeting, inflation targeting, and yet we never see the results promised from said policies.

Posted by: Ben Wolf | July 24, 2012 at 02:14 PM

I think the combination of low demand for both consumers and businesses despite the very low interest rate environment, the acceptance of these same low interest rates on the part of investors, and the inability of labor to gain meaningful rises in wages all suggest a considerable amount of slack in the global economy in general, and the U.S. economy in particular. Indeed, if I am correct, if government austerity measures continue, inflation is practically an impossible outcome over the next couple of years. The debt overhang is simply too great.

Posted by: m ellenberger | July 26, 2012 at 06:05 AM

We have little correctable long term slack in my view. Our lower skilled labors now compete at historically unprecedented intensity with lower cost, adequately educated, foreign workers who enjoy the competitive access offered by shipping technology advances. This situation is apt to endure. The ongoing rise of computers and robotics will continue to erode labor needs in factories and even in forestry. The nation should enjoy a temporary bounce-back over several years as housing markets return to some degree of normalcy. But long term, we suffer from having a standard of living that exceeds our capacity to compete.

Posted by: Marvin McConoughey | July 31, 2012 at 01:13 PM

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