Monday, February 13, 2012

Bullard and How We Measure GDP Gaps

Noah Smith had an early and excellent take down of Jim Bullard that included:

So, basically, what we have here is Bullard saying that the neoclassical (Solow) growth model - and all models like it - are wrong. He's saying that a change in asset prices can cause a permanent change in the equilibrium capital/labor ratio.

Tim Duy had another excellent take down of Mr. Bullard that included:

Estimates of potential GDP are not simple extrapolations of actual GDP from the peak of the last business cycles. They are estimates of the maximum sustainable output given fully employed resources. The backbone of the CBO's estimates is a Solow Growth model. So I don't think that Noah Smith is quite accurate ... Bullard can't be saying the Solow growth model is wrong because he doesn't realize that such a model is the basis for the estimates he is criticizing.

I was curious as to how much difference this makes so I extrapolates 2007QIV real GDP by assuming growth equal to 0.5% per quarter for the next four years and compared the GDP gap predicted this Bullard approach (GAP*) to the GDP gap one would get using the CBO estimate for potential GDP. Either way – we are still far below full employment.

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