In response to a comment by the author of the post I used as a starting point for my own post, Trend Spotting, I made a substantial comment which I thought deserved to be rescued from a now-dormant comment thread. Here it is.
GDP and, especially, GDPPOT (real potential GDP) aren’t facts. They’re calculations based on assumptions. If the assumptions are wrong or the calculations are wrong, they have no referent. They’re not just wrong. They’re meaningless.
Imagine a magic widget-producing machine. It produces widgets, so many an hour, without any inputs. The machine can’t be converted to any other purpose or even sold for scrap. All it’s good for is producing widgets.
Assume that people buy these widgets as fast as the widget-producing machine can make them. As long as people want widgets and are prepared to pay for them with money (or with credit as frequent commenter Ben Wolf might remind us), the widget-producing machine is a real money maker. What it adds to GDP is what people pay for the widgets it produces. Its contribution to GDP is based on its outputs not its inputs.
If people suddenly don’t want widgets any more, what does the widget-producing machine add to GDP? Zero. All other things being equal GDP in the present is therefore reduced from GDP in the time that people wanted widgets by the amount they were willing to pay for widgets before they stopped buying them.
That’s true whether the machine continues to make widgets or not.
In other words in my example there is no such thing as potential GDP.
In the real world it’s a lot more complicated than that. The GDP-producing machine that is the economy does have inputs and, when people stop buying some or all of a component that once added to GDP, over time some of the inputs of that component may be turned to other uses.
The way to facilitate that process is to reduce the barriers that inhibit the conversion process. Waiting for people to start buying the component again is nuts. Drawing a straight line from the old GDP trend line and labeling it “potential GDP” has no referent. Or, as Steve Verdon pointed out in comments, it’s no more provably true than any other line you might draw.
The not-so-usefulness of GDP targetting is why I think pursuing full-employment is a better strategy. We always know when the system is and is not performing at a level deemed acceptible by society because the measure is concrete, plus full employment is already written into law though the consolidated government largely ignores it.
No Dave. The best thing to do is to subsidize widget-making, preferably at all ends of the spectrum. Hopefully the widget-maker will buy more machines and increase GDP even further. If that proves insufficient, then some authority should mandate both the production and consumption of widgets. This will increase GDP further and will also increase employment. Really, Dave, get with the program.
Dave, I think you’ve just shown the uselessness of the GDP entirely, and in particular the concept of “aggregate demand”. Per Andy, when the demand for widgets falls off, the government can step in and buy the rest, preferably with credit. That would keep the GDP number right where it “needs to be”, as well as aggregate demand, and the Paul Krugmans of the world could rejoice.
“No Dave. The best thing to do is to subsidize widget-making, preferably at all ends of the spectrum. Hopefully the widget-maker will buy more machines and increase GDP even further.”
Unnecessary. Friedman already described the answer to ensuring demand: helicopter drops of cash into the streets. Put more money in the hands of consumers and they’ll decide what to subsidize with their dollars.
Helicopters and cash are like chocolate and peanut butter. Who do I write to provide my address?
I suppose this is stale and piling on, but yes, just because we don’t produce buggy whips anymore doesn’t mean there is an output gap.
It does cause one to wonder,though, about it’s genesis. Maybe there is an implicit medium term notion that supply and demand for the economy’s entire portfolio of goods and services goods is static if not for short term and temporary aberrations?
The buggy whip example confuses micro-transactions with macro-economics. Whether people do or do not acquire a specific good or service is utterly irrelevant. What matters when attempting to determine maximum GDP is spending because everything else is derived from it, including incomes and savings. If wages and spending lag behind productivity growth, for example, then by definition the economy is not performing to capacity. I’m afraid it isn’t as simple as drawing a line, as some are suggesting. The very fact we aren’t at full employment means we have idle resources not contributing to GDP and aggregate demand.
Resources are defined by their market value, Ben. The very fact that we aren’t at full employment means that the marginal productivity of employing a lot people does not exceed the marginal cost.
In other words, we’re completely superfluous people.
I wouldn’t say it quite that way, Icepick. I would say that we’ve raised the cost of adding employees too high. In the near term I only see two ways of dealing with that. Either the federal government can employ people directly in a CCC or WPA-type program or more of the costs can be socialized in various ways.
Oh, those aren’t the only two ways. There’s lots of nastier stuff that can be done.
And it is easy to say you wouldn’t put it that way, but I would. I’ve had a 60+ trillion dollar economy telling me I’m not even useful to clean toilets, and I’ve been getting told that for years now. What am I supposed to take from that other than that I am completely superfluous? Useless is a more precise term.