Growth in Potential GDP Since 1980

As another follow-up to David Altig, let me offer a bit of evidence provided by FRED (the Federal Reserve Economic Data) courtesy of the St. Louis FED. FRED provides a quarterly series of a measure of potential GDP (GDP* in my table) from the Congressional Budget Office. I have taken my four data points (1980QIV, 1992QIV, 2000QIV, and 2006QIV) and shown actual GDP (2000$) versus potential GDP. The GDP gap is also calculated to be around 2.4% as of 1980IV, 1.4% as of 1992QIV, negative 1.6 percent as of 2000QIV, and 2006QIV. From this, I compare the average annual GDP growth rates to the average annual growth rates in potential GDP.

As you look at the calculated GDP gaps, you might be thinking like me – don’t they look rather small? But suppose we add 0.6% to each figure – making our revised gap 3% when Carter left office, 2% when Bush41 left office, and around 1% now. Of course, we would still be showing real GDP above potential GDP about the time that Dick Cheney was to replace Al Gore as the Vice President. Didn’t Cheney say we were in a recession at the end of 2000? Or something like that? Whether we use the CBO gap figures or my suggested modification, the implied growth rates in potential GDP would be about the same.

I need to slightly alter something from this post with respect to this claim:

My case for using this time frame to estimate long-term growth is that we were in similar situations in regards the business cycle at the beginning of my 12 year period and at the end of it.

What we see in our table is that the gap was smaller just before Clinton took office than just before Reagan took office. So the 3.04% average annual growth rate for the Reagan-Bush41 era actually slightly overstates the growth in potential GDP. Of course, this confirms David’s point that potential GDP during the Clinton years was less than actual GDP growth, while actual growth over the past six years understates potential growth. But notice something: 3.2% still trumps the less than 3.0% growth in potential GDP that we’ve seen from those tax deferral Administrations.

So could it be – fiscal irresponsibility ala free lunch supply-side tax cuts is bad not only in terms of reducing national savings and long-term growth but also in terms of Keynesian macroeconomic stabilization policy? The GOP predicted that the 1993 tax increase would be followed by a recession, but as David points out, we didn’t see this predicted recession.