If you don´t care to go up to “meet him”, even if halfway, he´ll come all the way down to “meet you”!

Where “him” is the original trend and “you” is the present trend. I´ll explain.

The charts show the trend level path and the actual path of real output (RGDP) and nominal aggregate spending (NGDP) during the Great Moderation (1987 – 07) and beyond. For RGDP the trend growth rate is 3.3% while for NGDP it is 5.5%.

Meeting Trends

There´s no doubt that the economy was “shifted down” during what has become known as the “Great Recession”, and it looks as if this shift is “permanent”. Given that NGDP drives the process, as long as the Fed is quite happy remaining in the new lower trend level path, real output will “oblige”.

So I find comments such as this “Why the GDP Drop Is Good for the U.S. Economic Outlook” terribly amusing:

The U.S. economy shrank at a 1 percent annual rate in the first quarter, but the red ink isn’t nearly as scary as it looks. In fact, the downward blip sets the U.S. up for strong growth in the current quarter covering April to June.

Yes, when the economy falls below trend, it is reasonable to assume that it will rebound back to it. The only thing is that the trend it will rebound to is the new much lower one. And that´s something that makes me think that there´s a wide acceptance of the new trend.

What this implies is that over time the “old trend” will, for all sorts of economic reasons, “cease to exist”, in fact coming down all the way to become one with the new trend level, in which the real economy grows at 2.2% and nominal aggregate spending grows at 4%.

That is, surely, an enormous opportunity cost, and it can squarely be laid down to the obsession with inflation targeting!

4 thoughts on “If you don´t care to go up to “meet him”, even if halfway, he´ll come all the way down to “meet you”!

  1. So the old NGDP growth trend was 5.5% while the new one is 4.0%. In the long run, why would this affect the trend of RGDP growth? If the old RGDP trend was 3.3%, why would the new trend be only 2.2% (with 1.8% inflation), rather than 3.3% (with 0.7% inflation)?

  2. I still don’t get it. I take it you are endorsing the CBO estimates (is that wise?); but then *why* has RGDP’s potential for growth been “downgraded” (and why would looser monetary policy reverse that)?

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