More Output Gap Disaggregation

A blog about business and economics.
March 18 2012 1:01 PM

More Output Gap Disaggregation

The majority of the output gap – over 5 percentage points of GDP – could be closed by a return to trend of the construction of housing, hospitals and medical facilities and public infrastructure as well as an increase to trend in the production of transportation equipment.
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With the possible exception of the hospitals piece, the private side of this is your basic interest-and-credit sensitive sectors. Taylor Rule type considerations spent most of this period suggesting that interest rates should have been strongly negative. The Fed can't set negative nominal interest rates and declined to attempt to create negative real interest rates, and you got more or less the outcome you would expect from interest rates being too high.

If a Taylor rule had been consistently recommending a 2% fed funds target rate over the past 4 years and the Fed had instead kept its target rate at 6% over that time, not a single economics writer in America would wonder why growth had been so abysmal. 

The Fed could do an awful lot to help out by simply tweaking its current statement. Instead of saying that it expects conditions will continue to warrant etremely low rates through 2014, they should pick a number—5 percent say—and say that they definitely won't raise rates through late 2014 unless inflation goes above that figure.

Matthew Yglesias is the executive editor of Vox and author of The Rent Is Too Damn High.