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squidkid's avatar

This is quite possibly the worst-researched Slow Boring post I've ever read. While I appreciate the general argument that government officials should work harder to achieve full employment and be less scared about inflation, your understanding of macroeconomics is clearly faulty and your criticisms miss the mark. Three quick points:

1) Fundamentally, I you seem to misunderstand the underlying concept of "potential output". Your post implies that when the economy exceeds potential, we should be seeing runaway inflation and exceedingly tight labor markets. In some sense, this is right. But exceeding potential is not a switch that is turned to "On" or "Off". Instead, it's like a dimmer switch. If we exceed potential output by a little bit, inflation will accelerate a little bit. If we exceed potential output by a lot of bits, then we're likely to get runaway inflation. Now, we can argue what constitutes a little bit vs. a lot of bits, but my view is that a 1% gap between GDP and potential is not a lot. Consistent with that view, inflation was a little higher in 2018-2019 than it was in preceding years but not radically higher.

Put another way, you should not think of potential output as a limit that cannot be exceeded for fear of runaway inflation. Rather, you should think of it as the maximum output an economy can produce without generating ~inflationary pressure~.

2) Your post implies that you have no idea how CBO constructs its estimate of potential output. This is a weird take, given that their methodology is publicly viewable in a document written by Shackleton (2018). Basically, CBO uses a supply-side model in which they estimate potential labor hours, potential capital services, and potential labor/capital productivity. Those factors are estimated by looking at historical trends in each series. It's fair to quibble over specific modeling assumptions, but I'm not sure you've actually read through their methodology. Here's a link: https://www.cbo.gov/publication/53558

3) Before you accuse CBO's forecasting of being "bad", I'd encourage you to read CBO's Economic Forecasting Record (2019). The report examines two-year and five-year forecasts made between 1980 and 2017. It compares forecasts made by CBO, OMB, and the Blue Chip consensus of private sector forecasters. The report finds that CBO's forecasts are generally more accurate than OMB's forecasts and roughly comparable to the private sector forecasters. This finding extends to the agency's interest rate forecasts, which seem no better and no worse than those produced by other organizations. Essentially, forecasting interest rates is highly challenging, and this is especially true in our anomalous interest rate environment. Instead of dunking on the CBO, you should understand the inherent difficulty of their task. Here's a link to the forecast accuracy report: https://www.cbo.gov/publication/55505

I'll conclude with my own thoughts on this issue. I think Larry Summers and the CRFB are being overly cautious with regards to the need for more fiscal stimulus. I'm much more closely aligned with Janet Yellen, who argues that the risks of a too-small stimulus far outweigh the risks of a too-big stimulus. But your decision to criticize a nonpartisan bureaucracy for making average to above-average forecasts is an odd way to channel your frustration. Instead, you should direct your ire toward the people who are ~actually~ calling for less stimulus instead of scapegoating the CBO.

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John E's avatar

This falls apart for me in a couple of ways.

1) I agree with you that we should run the economy a bit hotter to try and attain greater full employment, but policy to achieve this should not come at the expense of government fiscal situation.

2) More to the point, having just recently lived through the great recession, why would you be willing to trust the market's perception of risk so completely? I would completely back allowing the fed to run hot for a couple of years, but would want the US budget to be improving in the process (lowering debt/GDP). Running them both to the max seems like setting ourselves up to run off a cliff with no safety net. Your argument here sound very much like the motivated reasoning that republican's give when they talk about their tax cuts paying for themselves. They have the solution they want regardless of whether it matches the problem.

3) In a very specific instance, I want a government that is trying to find good solutions to problems it can solve. I don't want a government where the parties are competing over who hands out more cash. That is ripe for horrific results and terrible government. $1,400 checks to people who aren't unemployed and especially to people who make over the national median income is appallingly bad policy.

4) More broadly, many progressives hold up the example of the Nordic countries as the social democracy they are aiming for and rebut suggestions that they are Venezuela or Argentina. One of biggest differences between the two is that the Nordic countries are willing to pay for the benefits. The the SA countries experience severe economic pain from wild spending that wreck their budgets but they are unable to stop spending because they have to buy votes.

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