Does anyone else see a problem here? Those who crunch the data see what they want to see and disregard the rest. If you want to see low unemployment, you find data that gives you low unemployment. You don’t look at contrary measures.
The Fed has taken this position in spite of the fact that most Fed economists truly believe in the Phillips curve. They just don’t believe in it enough to take it to its logical conclusion, as 720 Global did.
Then there’s “potential GDP,” or the nation’s theoretical maximum noninflationary output. What does it tell us? First, note that we barely have a grip on actual GDP, even though it is a function of (mostly) observable data. A small army of people spend their entire careers collecting GDP inputs. They do a fine job, too; but no one really knows if they are collecting the right data to support the conclusions everyone draws. Further, GDP does not measure all the things that we used to buy at significantly higher prices, which contributed to GDP but are now (for instance) available in our phones for “free.”
I have spent entire letters talking about the limitations of GDP measurement. I thoroughly understand why we must have the measure, but we need to recognize what it is and isn’t. It is not a meaningfully, accurate number delivered from Mount Olympus by the economic gods. It is, at best, a concatenation of approximations, the movement of which, based on those approximations, can give us insights into the economy—but not with any real precision. Google Maps gives you very precise directions. The GDP number is more like “We are going west; we are not going north.”
We then use this estimated GDP, this fuzzy and incomplete growth measure, to infer potential GDP, or how high this nebulous number could go if some of its inputs changed. Then we wonder how close we are to this vague derivative of an incomplete measure of a hypothetical construct, so that we can modify fiscal and monetary policies. It’s important to understand that if we have in fact now begun to exceed our potential GDP, then economic theory suggests that inflation – and perhaps not even mild inflation—is right around the corner. I am not a doctorate-holding economist, but to me this seems an unwise assumption to make.
Others think so, too. Here’s Jared Bernstein again:
It’s true that influential institutions such as the Federal Reserve and the Congressional Budget Office (CBO) believe that the “natural” unemployment rate is above the current one, meaning our labor force is beyond fully employed. Their estimates are 4.6 percent and 4.7 percent, respectively, while the actual rate is 4.1 percent. The CBO also asserts that our current level of GDP—$19.7 trillion—represents full capacity.
But the evidence undermines much confidence in these authoritative-sounding point estimates. First, understand that neither of these measures—the natural rate or potential GDP—can be observed. They must be estimated based on the movements of other variables. For example, the key relationship underlying the natural rate is the one between unemployment and inflation, with the basic insight being that once economic capacity is exhausted, any more demand just shows up as more inflation (note the link between the debate over fiscal spending right now).