This month, the US economy has been growing for 10 years running, tying the record for the longest expansion ever. Many people, including journalists and policy makers, see this as a great achievement.
“I see nothing to celebrate. On the contrary, I think they are measuring success the wrong way”, says Narayana Kocherlakota
He says, “Imagine that you were offered 2 different pay options for the next six years: Which would you take? Plan 1 shows consistent growth. Plan 2 is more variable, but it generates as much or more income every year. If what you want is more money, Plan 2 is clearly preferable.
The same logic should hold for US output per person: More is better. Yet most economic observers would choose Plan 1, because it features 6 years of steady expansion. Plan 2, by contrast, has a terrible “recession” from 2023 to 2024, and arguably an “overheating” economy from 2021 to 2023.”
Economy watchers often point to the absence of a recession in the past 10 years as a sign of good policy making by the Fed and others. But, being recession-free may not be the best outcome. As, long frames without slumps often indicate many years of poor economic performance.
The Big Q: What is a better way to keep score?
The Big A: 1 option is to use the “output gap,” that is the percentage difference between actual output and what the nonpartisan Congressional Budget Office (CBO) estimates the economy could produce if it were operating at capacity, with all able workers and capital fully engaged. A negative number means the economy is not meeting its full potential, while a positive number means it is going too fast.
The past 10 years has been the worst in the past 70 years. Despite the lack of recessions, the economy has been operating well below potential for much of the time. And the output gap has been negative through almost all of the current millennium. The US would actually have been better off with a decade like the 60’s.
Fed officials are meeting this week to review their framework, meaning the way they assess the economic environment and seek to manage employment and inflation through their monetary policy choices.
It is very important that the FOMC use the right measure to judge how well they are doing their job.
“Good policy should not be about keeping output below potential to avoid possible recessions. It should be about making choices that lead to the highest possible output and employment, without unduly high inflation. Focusing more on a measure like the output gap could help them achieve that goal.” said Narayana Kocherlakota
Editor’s Note: Narayana Kocherlakota is a professor of economics at the University of Rochester and was president of the Federal Reserve Bank of Minneapolis from Y’s 2009 to 2015.
Making and Keeping America Great!