How large is the output gap really?

Via Mark Thoma, and drawing upon James Bullard at the St. Louis Fed, MacroMania writes:

I think that Bullard makes a persuasive case that the amount of household wealth evaporated along with the crash in house prices should likely be viewed as a “permanent” (highly persistent) negative wealth shock. Standard theory (and common sense) suggests a corresponding permanent decline in consumer spending (with consumption growing along its original growth path). The implication is that the so-called “output gap” (the difference between actual and “trend” GDP) may be greatly overstated by conventional measures.

There is still not enough talk of wealth effects in current macro debates, as they are invoked only selectively.  Note by the way that if you see the output gap is somewhat smaller, you will think today’s recovery is somewhat better, not in absolute terms, but relative to potential.

Here are some interesting observations about  Bullard.

Addendum: Here is comment from Scott Sumner, and Matt Yglesias.  You’ll note my post is itself non-committal, though I certainly do not dismiss this argument.  Simplest response to Sumner and Yglesias is that we may have had a biased estimate of the previous trend, for bubble and TGS-related reasons.


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