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Low potential?

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Some folks think that it’s a mystery that GDP has been so weak and that the unemployment rate remains low – but I’m not so sure.

If you look at the Okun relationship (change in Unemployment rate v. change in GDP), the labour market outcomes over the prior year are actually a little weaker than you might have expected.

One might object that this sample includes the still-curious breakdown in the relationship in the mid-naughties. That’s a fair point.

Averaging over the post 90s period, it looks like 3% is enough to hold the unemployment rate down – and given that, our labour market performance is bang on what you’d expect.

My assessment is that potential growth may be more like 2.75%. If this is the case there is little scope to ease monetary policy at present, and more of the fiscal deficit is structural than it seems.

11 comments

  1. The problem on the structural side is tax as Martin Parkinson observed to the ABE luncheon.
    The structural deficit doubled yet policy was contractionary.
    The reason. Problems of tax revenue

  2. If the government brings down a balanced budget ( i.e. it is the black but is less than 1% of GDP) and they have done this when GDP growth has yet to get to 3% then it is very hard to claim fiscal policy is anything but quite tight.

    Indeed the RBA could be thought of having rates to high because they have consistently over-estimated the impact of commodity prices.

    1. I think those who worry about the budget’s structural position, and i am one of them, worry about a decline in commodity prices. If commodity prices go back to average, the structural position is a very large deficit.

      You are right that they are moving to surplus and that the movement is contractionary.

      Sent from my iPad

    1. Exactly.

      So much padding, and guff, and so little reform. We missed a golden opportunity for structural improvement.

  4. Interesting analysis, but I would say the relationship is pretty weak;
    R2 of .3 and .5 are hardly strong.

    Agree on the reform comments, but all that will be remembered is that Labour were in power when it went all pear shaped. No one will remember the decade of inaction.

  6. you seem to believe the potential growth rate li lower than what the RBA believes.

    Why’s that

    1. mostly because the unemployment rate has been stable at lower average rates of growth for a long period of time. it’s our weak productivity…

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