[PEN-L:29545] RE: Re: RE: Re: PK on current events

["Devine, James" <jdevine@xxxxxxx>]

Title: RE: [PEN-L:29542] Re: RE: Re: PK on current events

Ben writes:
>Michael and James - if either of you have Krugman's _Age of Diminished
Expectations_ lying around, you might check out pp. 60-61 where he
describes the "output gap" of the recession of the early 1980s, induced
to combat inflation. This is how's he's constructing the trend line:

>"Figure 13 shows the picture, which is about as clear as anything in
economics. It shows two lines.  One line represents 'trend' output: a
projection of what the U.S. economy would have produced during the 1980s
if it had continued to grow steadily at the same 2.4 percent rate at which
it grew from 1973 to 1979.  This trend line represents a rought estimate of what the U.S. economy could have produced if it had been running at more or less full capacity.  The other line shows the actual gross national product, which fell sharply below the trend line from 1979 to 1982, and did not get back close to the trend line until 1987. The gap between these two lines - the difference between what the economy could have produced and what it actually produced - represents a rough estimate of the cost of America's war on inflation. This gap peaked at 10 percent of GNP in 1982 and averaged 3 percent over the seven years from 1980 to 1986..."<

This is standard textbook macroeconomics. The same kind of results can be derived by looking at how high unemployment rates were during that period.

>So if he's doing the same thing in his most recent article, I'd guess
he's just taking the growth average for the mid to late 90s and comparing it with the actual growth for the last couple of years. <

He's more likely comparing it to a trend of real GDP over a decade or more.
JD
-----
 
>Michael Pollack asks:
>How would one go about calculating this output gap from publicly
>available figures?

I wrote:
>the basic is to calculate potential real GDP. There are two steps here. First, add the trend in average labor productivity for the economy as a whole to the trend in the labor force. Or just calculate the trend in

real GDP. (I would use some sort of polynomial approximation.) Then, in
order to calculate the level of potential, choose a base year when you think the economy was at potential (1999?) and use that to figure out what the level of real GDP is along the trend line. Conservatives would choose a year when unemployment was high, so that we had above-potential production in 1999. Liberals would choose a year like 1999, so that the GDP gap is large, but it turns out that the GDP gap (potential minus actual real GDP) moves together no matter what year is chosen.<

>Or you could use numbers from the Office of Management & Budget or the
>Congressional Budget Office.