Tuesday, February 2, 2010

The CBO Estimate of Potential Output: A Depressing Future

When the GDP figures came out last Friday morning (29 January,) I wondered how real GDP compared to potential output. Had the CBO put out the figures for 4th quarter potential output?

Then I remembered, there is no problem. The CBO has estimates of potential output for the next ten years!

The St. Louis Fed provides the CBO figures for potential output from 1949 until 2019. The growth rate of the CBO measure of potential output for the entire period is 3.15 percent. The growth rate of real GDP during the period (up until fourth quarter of 2009, of course) is 3.23 percent.

The trend growth rates of real GDP and potential output are on top of one another. The beginning of the Great Moderation is clearly visible as reduced fluctuations of real GDP starting in 1984. The CBO's estimates of the growth rate of potential output for the next decade are also clear--well below trend.

The following diagram focuses in on the Great Moderation and Great Recession.

The CBO's estimate of potential output has been falling below trend since the third quarter of 2002, but the drop became sharper after the fourth quarter of 2008. CBO forecasts even lower growth of productive capacity in 2010, though it will pickup a bit later.

The trough for the growth rate of potential output is the third quarter of 2010, at 1.48 percent, and then recovers, reaching 2.66 percent in the third quarter of 2014, before a downward glide towards 2 percent.

The gap between the CBO's estimate of the growth path of potential output and the 3 percent trend growth rate of real GDP grows quite large in the out years

Again, looking at the Great Moderation and the Great Recession, the divergence shows up clearly. Real GDP fluctuates around its trend, and then, after the mild recession of 2001, it stays below trend along with slow growth of potential output. While housing may have been booming during 2004 and 2005, real GDP was below trend and right at the CBO's measure of potential output.

These CBO estimates are quite depressing. The gap between the 3 percent trend growth rate in real GDP and the CBO's estimate show up even more strongly in their forecast.

In 2019 there is a 15 percent gap between the CBO estimate of potential output and the trend growth path of real GDP. That is $3 trillion of goods and services (at 2005 prices.) Perhaps the CBO is forecasting U.S. convergence with our new role model, France?

I favor a 3 percent growth path for nominal expenditures because the 3 percent trend growth path of real output should result in zero inflation on average. However, if the U.S. is about to embark on a decade of 2 percent growth, perhaps slower growth in nominal expenditures is desirable.

No comments:

Post a Comment