Estimates of potential GDP are not simple extrapolations of actual GDP from the peak of the last business cycles. They are estimates of the maximum sustainable output given fully employed resources. The backbone of the CBO’s estimates is a Solow Growth model. So I don’t think that Noah Smith is quite accurate when he says:
So, basically, what we have here is Bullard saying that the neoclassical (Solow) growth model – and all models like it – are wrong. He’s saying that a change in asset prices can cause a permanent change in the equilibrium capital/labor ratio.
Bullard can’t be saying the Solow growth model is wrong because he doesn’t realize that such a model is the basis for the estimates he is criticizing. [first and last link in the original; Noah Smith link copied from elsewhere in the original post]
Go Read the Whole Thing. For those of you too lazy to do that without incentive, here’s the conclusion:
Bottom Line: Bullard really went down an intellectual dead end last week. He criticized the focus on potential output, but revealed that he doesn’t really understand the concept of potential output either empirically or theoretically. He then compounds that error by arguing against the current stance of monetary policy, but fails to provide an alternative policy path. And the presumed policy path, tighter policy, looks likely to only worsen the distortions he argues the Fed is creating. I just don’t see where Bullard thinks he is taking us.