Go on over to
Barry Ritholtz’s Invictus at The Big Picture’s post on GDP and take a look at the first graph. It’s from the invaluable FRED database of the St. Louis Federal Reserve and juxtaposes real gross domestic product from 1990 to the present with a purported potential real gross domestic product.
Leave aside that GDP is a construct (by construct I mean an artifact that may or may not have a real world referent; its relationship to a real world referent is assumed) as is real GDP, derived by adjusting the calculated gross domestic product by an imputed rate of inflation. Potential real GDP is, apparently, GDP if it increased at a fixed annual rate.
IMO there is very good reason to believe that potential real GDP is hooey—something with no real world referent. To believe otherwise is to believe that misallocation of resources has no effect on the economy.
Consider real GDP during two different periods on the graph: 1994 through 1996 and 2000 through 2003. Rather clearly real GDP during those periods grew more slowly than the presumed trend. Each of those periods was succeeded by a bubble, the dot-com bubble and the housing bubble, respectively. The interpretation implicit in the potential real GDP story is that these two bubble were merely a return to trend.
IMO that flies in the face of the facts. Those two bubbles were specific responses to events and policies, in the case of the first bubble a change in the treatment of capital gains under the tax law and in the second Federal Reserve policies. Rather than returns to the previous trend they were artificial and non-sustainable attempts at subverting the new trend.
There’s a reason there’s a $1 trillion hole in the economy: it was never there to begin with. We just thought it was. We’re not as rich as we thought we were.
Take a gander at the updated real GDP graph drawn by regular commenter Andy. Note particularly the update—the green line. I understand why one would prefer to believe in the potential real gross domestic product as calculated. I’m not convinced that it describes anything that’s not an artifact, is realistic, or sustainable.