Monday, May 12, 2014

Declining expectations

Philadelphia Fed President Charles Plosser made this nice graph, showing how reduced views of potential GDP are closing the gap, not rises in actual GDP. The source is a nice speech here.  This fits in the recent series of blog posts on forecasts and slump. By contrast, here is the last big recession, where GDP closed the "gap."


  1. Doesn't the fact that the early 80s recession was largely policy induced by the Volcker Fed, and then "cured" by subsequent Fed actions (and the fall in energy prices) make the comparison a bit meaningless?

    1. The answer is yes. Even assuming that the blue line in the second graph is the pre-recession forecast (I do not know that it is).

  2. Spot the last big recession in this graph:

  3. If this site is any indication about the behavior of graduate students and professors in economics profession then no doubt the profession as a whole is losing its relevance:

    This site frequented by practitioners in economics profession is full of racist, homophobic, and misogynistic rants. Any kind of serious economics discussion is discouraged by the site owner and moderators. Vile threads and comments are not only tolerated but also encouraged.

    No wonder the profession is in such a mess now. Just have a look at that site and you will see what I mean.

  4. Around 2009 Jim Sinclair coined the acronym MOPE - Management of Perspective Economics. The CBO's GDP predictions are just MOPE, a variation on "Prosperity is just around the corner".

    They always refer to the "Nonpartisan CBO". Ain't no such animal inside the Beltway.

  5. Errors in quarterly consensus GDP here

    There doesn't appear to be a consistent overly optimistic bias. They are both over and under, and occasionally close.

  6. Prof Cochrane, I wonder if there is an index/ranking for the historical reliability of forecasts sources. E.g.: Who's been better at predicting the US GDP in 5 years time? The Fed, the world bank? Goldman Sachs? I suspect they all do quite poorly.

  7. As the break downward was in 2007, What did the Bush Administration due that caused the break from trend?

    1. John,

      The trend broke when Bush decided on the domestic front to put all his eggs in the housing basket. No consideration was given to trade balance or a declining manufacturing sector. Bush, in short, got deluded into thinking that you can borrow your way to prosperity. Worked well enough when housing prices rose faster than borrowing costs.

      That mentality still exists in the Republican Party to this day. Notice every Republican out there wants to tackle "runaway government spending" and yet few (none?) will offer constructive solutions on tackling debt.

      Here is Mr. Cochrane's solution:

      "Constructing a financial and monetary system which is immune both to private and to public default is an interesting question. Rather than pursue a fundamentally different monetary standard—substitute bitcoins, gold, or SDR (special drawing rights) for short-term nominal Treasury debt—I think fairly simple innovations in government debt would suffice. If the government were to issue long-term, ideally perpetual, debt that comes with an option to temporarily lower or eliminate coupons, without triggering a legal or formal default, then government financial problems could be transferred to bondholders without crisis or inflation."

      A better solution - one that doesn't involve discretionary suspension / restitution of coupon payments - would be for the federal government to sell equity claims against future tax revenue. Potential rate of return is set by government, realized rate of return is achieved by tax payer.


    2. One might also reference the policy and malinvestment precedents set with the US savings & loan (aka thrift) industry. The then current regulatory wisdom lead to the point as reported by the Treasury in 1985 that

      - the industry in aggregate operated with tangible net worth/ total assets of less than .5%;
      - technical insolvency of then some 300 S&L's;
      -less than 1/3 of the industry had FHLBB examination ratings indicative of good performance; and some 23% classified as troubled
      - 70% of aggregate thrift funding linked to short term money market rates
      - funding portfolios of long duration, fixed rate assets with a turnover rate of 25%

      We've been manufacturing stupid for a long time.


    3. I have very detailed knowledge of the S&L crisis all the way down to the date and time of the critical meeting told to be personally by Frank Gailor, GC, FSLIC. Jimmy Carter called in FSLIC after he lost a primary to Ted Kennedy and ordered FSLIC to lift rates on deposits so that savers would get higher rates and be bribed to vote for Carter.

    4. John

      Is "Esq" Latin for pompous person?

    5. No, it is Latin for crackpot. You cannot hide from me, John D, I see everything.

  8. I read the paper and Plosser comes close to saying the obvious but never quite does - that extrapolating a trend line from the height of the housing and financial bubble is ridiculous. The period 2002 to 2008 saw an economy massively stimulated by the Bush tax cuts, government deficits and private deficits. It also saw a serious mis-pricing of the value of new homes being constructed. There is no reason to think that measured GDP in 2007 was somehow sustainable. If we look at 2001 to 2003 for our baseline, the economy appears to be roughly on trend.

    I agree with Plosser's conclusion that the focus needs to be on robust policies that are not vulnerable to measurement or model errors.

  9. Currently reading your paper that Nick Rowe wrote about.
    Also I have a method to determine potential GDP. And potential GDP is not going to rise. It is on a new lower trend line according to effective demand. Here is a link to a post...

    The post has a section on potential GDP. There is also a section on the Fisher effect which you write about in your recent paper.


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