Saturday, July 28, 2018

Krugman: Why One Quarter’s Growth Tells Us Nothing [feedly]

Why One Quarter's Growth Tells Us Nothing

For the most part, reporting on 2nd quarter growth has been pretty decent. But I haven't seen clear explanations of why one quarter's growth tells us so little about longer-term growth prospects. I'm sure that reporters get it; maybe they assume that readers already know (a very bad assumption), or maybe they're afraid of sounding too technical. But anyway, it seems as if there's a gap worth filling; so here it comes.

The key point when you look at real GDP is that the economy's actual output depends both on its capacity – the amount it is capable of producing on a sustained basis – and the rate at which it is using that capacity. That is,

Output = capacity * capacity utilization

CBO actually produces an estimate of capacity – "potential GDP" – which you can argue with, but is a useful benchmark. And you can look at the ratio of actual GDP to potential, which is an indication of how hot the economy is running:


Why does capacity utilization fluctuate? Mainly because the economy sometimes suffers from periods of inadequate demand, as it did after the 2008 financial crisis. Sometimes, also, the economy overheats, reaching levels of capacity utilization that will lead to rising inflation. The Fed thinks we're in or near to that state now, although many economists disagree. Whoever's right, the point is that there's some limit to how hot the economy can run.


Now, suppose that for whatever reason capacity utilization rises. This will generate a period of rapid growth. To take a not at all arbitrary example, suppose that capacity is growing at a 2 percent annual rate, and capacity utilization rises 0.5 percent over the course of a quarter. Then growth in that quarter will be at an annual rate of 4 percent (because half a point in a quarter is two points at an annual rate.)

This, however, says nothing at all about whether the economy can achieve 3 or 4 percent growth over a longer period, say a decade. That would require evidence of an acceleration in the growth of capacity.

So does 2nd quarter growth say anything at all about the Trump economic agenda? The tax cut probably helped give the economy a bit of a bump: massive deficit spending will do that. (Obama could have presided over a much more rapid recovery if Republicans hadn't insisted that deficits and debt are vast evils – but only when a Democrat is in the White House.) But deficit-based Keynesian stimulus wasn't how the tax cut was sold, and isn't a basis for sustained growth.

In short, one quarter's growth is a nothingburger. The real news is that we're still waiting for both the investment surge and the wage gains the tax cutters promised; as far as we can tell, they're never coming.

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