Saturday, February 18, 2012

How much sense does it make to use capacity utilization to talk about the output gap?

Tyler Cowen links to this post, which argues that the output gap is smaller than advertised. One of the key indicators cited is capacity utilization, which is not particularly low.

But how much sense does this really make in an economy where investment demand is a major part of the problem? In shorter recessions, supply shocks, etc., capacity utilization seems like a fair enough indicator to look at. But if this is a recession where investment demand is the source of the problem, you're going to be depressing the numerator and the denominator of the capacity utilization figure.

In other words, the method that Cowen cites to argue that the CBO estimates are biased upwards seems itself to have an inherent downward bias.

If the nature of this depression were different, perhaps this would still work. But it seems highly suspect to rely on a capital stock related measure to talk about this sort of thing if it's precisely capital accumulation that's our problem!

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