Tuesday, October 5, 2010

Actual Real GDP vs Potential Real GDP...VERY nice interactive graph for this IMPORTANT concept

     These graphs below are part of an interactive available HERE on the relationship between ACTUAL RGDP and POTENTIAL RGDP.  In addressing the problems in our economy, it is critical to understand the difference between the two.  I can see the Production Possibilities Frontier, Short-Run Aggregate Supply and Long Run Aggregate Supply implicitly and explicitly through-out.  I have copied and pasted the two most important parts below, but if you go to the link you can build the models yourself step by step. 
     In the first graph, the ideal situation is for the lines to run parallel to each other with no gap. This means that our actual GDP production is equal to our potential to produce GDP given our resources and full-employment of those resources (people first and foremost).  When you see blue, we are actually producing beyond our potential. Unemployment is very low, which can be a good or bad thing  (more on that in class). Where you see pink, it means actual GDP is below potential GDP---we are in a recession and unemployment is high. This is where we currently find ourselves.


Graph copied from Ezra Klein
     This second graph below shows the data from the graph above PLUS how unemployment would be affected given different GDP growth rates.  If our GDP increased at an annual rate of 6% we would reach the Natural Rate of Unemployment("NRU") of 5% rather quickly (2012). The NRU is considered the lowest unemployment rate we should reach if we are fully employing all our resources.  It is impossible to reach an actual unemployment rate of 0%. There is always some frictional and structural unemployment no matter how good the economy might be performing.  However, NO reputable economist is predicting that high a growth rate anytime soon.  It seems more likely we will be in between 2%-3% average growth rate for the foreseeable future and we won't reach full-employment until the mid to late 20-teens.  Hmm...about the time the class of 2011 graduates from college...that is the good news...

Graph copied from Ezra Klein
""Compared with a healthy economy, about 7 million working-age people and 5 percent of the nation’s industrial capacity are sitting idle, not producing what they could. The economy is growing again, but at a rate — less than 2 percent in recent months — that’s too slow to keep up with a population that keeps increasing and workers who keep getting more efficient.
This is the output gap, the divide between the amount the United States can produce and what it is actually producing. The gap, currently $900 billion, explains why we feel so miserable more than a year into what is technically classified as an economic recovery.""

3 comments:

  1. Nice, Gene. (I've been assembling a little something myself on potential output lately. Good timing.)

    But Klein is funny. He says the graph shows "what's wrong with the economy." Not even close! It only shows there is something wrong with it.

    But it seems that the CBO has found a way to reduce the output gap: The CBO's estimates of the growth rate of potential output for the next decade are ... well below trend.

    Art

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  2. Art--I can read between the lines of what you are saying. The more I read what you have written the more I see where you are coming from and I more clearly see how the advancement of credit in the last 30 years or so has not served us well. I am discussing Monetary Policy with my AP class in about 2 weeks and I am going to mix in some of your graphs and "steal" some of your ideas to present to my students to think about alongside of the "official" curriculum...Thanks again for keeping me on my toes! :)

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  3. Funny thing, Gene. Late '70s, early '80s maybe, when I recognized the conflict in policy (encouraging credit-use while restricting money-growth) it hit me in the head like a two-by-four. Since then it has been so easy for me to see it, but so hard for me to get anyone else to see it. You are the least "iffy" about these ideas of anyone, in all that time.

    Please, make use of the ideas and graphs. (Just remember the source!!)

    Art

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