This article by Bullard is a response to a critique by Tim Duy which I posted yesterday. The article gets quite technical but, at the risk of oversimplification, Bullard argues that we should not use the GDP that we observed during the rise in housing prices as our measure of potential GDP that is used to determine our current output gap. Potential GDP was inflated by spending in this period in excess of what it have been without the housing bubble which distorted behavior. If we lower our estimate of potential GDP, to correct for the distortion in spending due to housing bubble, our current output gap would be much lower. His point is that Fed policy should not be based upon an inflated value of potential GDP.
Bullard makes a good point that may get lost in economic jargon. GDP would have been much lower than it was if it had not been fueled by real estate development, and by household spending that was derived by refinancing mortgages and taking out home equity loans. This is not good news, however, it suggests that our economic growth rate will be much lower without future asset bubbles that stimulate consumption.
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