In his most recent blog post, sizing up the current macroeconomic situation, Nobel Laureate Paul Krugman posts this chart of the so-called “output gap”
So we’re something like 8 per cent below where we should be. That translates into lost output at a rate of well over a trillion dollars per year (as well as mass unemployment). And we’ll keep suffering those losses, even if GDP is now growing, until we have enough growth to close that gap. Since there’s nothing in the data or anecdotal evidence suggesting any gap-closing in progress, this is a continuing tragedy.
Here’s what we don’t get though, and one of Krugman’s commenters brings this up: How can we even talk about what output should be when that red trend line was based on an economy driven by inflated home values, excess debt, cheap money and overconsumption driven by increasing home values?
Krugman, of course, uses the divergence to show the need for more stimulus money, hence he calls it a “continuing tragedy.” But if you don’t accept that the red line was sustainable or real at all, the case for stimulus to get us back to that red line becomes much weaker.
We’re curious your thoughts, and whether you think this output gap is a meaningful measure.