John Taylor puts a wet blanket on the recent pick up in GDP. He feeds the GOP criticism about the failure of the "Keynesian stimulus". He compares the more rapid recovery from the 1981 recession with our current recovery and shows that GDP is still well below trend. Other conservative economists, e.g. Barro have made similar comparisons with more recent recoveries. They conclude that it proves that fiscal stimulus does not work. The other possibility is that this recession is really different. We have a balance sheet recession as a result of the bursting housing bubble, and we had a financial crisis on top of the recession. Long recovery periods are common under those conditions. Curiously, I earlier posted a critique of another attack on Keynesian theory by another conservative economist (Tyler Cowen) who argued that our recent growth in GDP proved that Keynesian theory has been disproven. Poor Keynes, he loses no matter what happens in the economy.
An interesting debate is also also going on about the long term trend in GDP growth. Our current output is still well below the long term trend. Policy is directed toward reducing the "output gap" between current output and the trend. Some argue that the long term trend may have to be reduced. They argue that the trend was inflated by the housing bubble and that the loss of wealth from the collapse in housing will have a permanent effect on the GDP growth trend. Therefore, it is a mistake to base policy on reducing the output gap. We should be more concerned about the potential for inflation that might result from Fed policy than about reducing unemployment. Bernanke believes that inflation and unemployment should be equally weighted. Others argue that unemployment should have a larger weight.
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