Saturday, August 7, 2010

Output and employment gaps in the US and Europe

One of the distinguishing features of the Great Recession, especially among the developed economies, has been the persistence of weakness in both aggregate demand and in the labor market. Accordingly, both output and employment rates have deviated significantly from the potential trend lines.

Given the considerable damage experienced by the household and business balance sheets, the San Francisco Fed has estimated a large output gap which is estimated to persist well into the next few years.

The CBO's analysis of the Budget and Economic Outlook (presentation here) made in February 2010 reveals considerable unemployment rate gap...

... and GDP gap

Mark Zandi and Alan Blinder have this assessment of the employment gap

Paul Krugman points to the lock-step nature of co-movement between the US non-residential fixed investment spending (or business investment, as a percentage of GDP) and the US output gap (the percentage difference between real GDP and the CBO’s estimate of potential real GDP) over the past two decades, to argue that business investment should, if anything, be even lower.

Assuming a conservative output gap of 6% in the US and a trend growth in potential output by 2%, the US economy would need to grow by 3% every year for six years to get back to normal. At 4% growth, it would take 3 years to bridge the potential-output gap. Mark Thoma feels that the unemployment rates could remain high for many years to come.

Ezra Klein points to this superb graphic (from a Brookings study) that shows the number of months of job growth it would take for the labor market to return to normalcy. Adding new jobs at a rate of 200,000 a month would take us 150 months - or 12.5 years - to get back to normalcy.

Krugman points to a considerable and widening output gap across Euro zone, with 2007 fourth quarter set at 100 and assuming a 2 percent annual growth in potential output.

Update 1 (19/8/2010)
Excellent series of graphics from CBPP, including this on the potential-output gap in the US economy.

Update 2 (7/10/2010)

Superb interactive graphic on the employment and output gaps in the US.

Update 3 (27/11/2010)

The first estimatees of third quarter GDP growth was an annualized 2.5%. But despite this and five straight quarters of economic growth, the demand for goods and services ("actual GDP") remains about 6% ($955 billion) less than what the economy is capable of supplying ("potential GDP").

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