Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy

The recent financial crisis and ensuing recession appear to have put the productive capacity of the economy on a lower and shallower trajectory than the one that seemed to be in place prior to 2007. Using a version of an unobserved components model introduced by Fleischman and Roberts, we estimate t...

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Bibliographic Details
Published in:IMF economic review 2015-04, Vol.63 (1), p.71-109
Main Authors: REIFSCHNEIDER, DAVE, WASCHER, WILLIAM, WILCOX, DAVID
Format: Article
Language:English
Subjects:
Aggregate demand
Analysis
Capital Markets
E230
E320
E520
Economic aspects
Economic conditions
Economic crises
Economic crisis
Economic models
Economic Policy
Economic recessions
Economic recovery
Economic theory
Economic trends
Economics
Economics and Finance
Employment
Forecasts and trends
GDP
Gross Domestic Product
Inflation
Inflation (Finance)
Influence
International Economics
Labor force
Labor productivity
Macroeconomics/Monetary Economics//Financial Economics
Monetary policy
Phillips curve
Potential gross domestic product
Potential output
Production functions
Recessions
Studies
Supply side economics
Trends
Unemployment
United States
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Summary:The recent financial crisis and ensuing recession appear to have put the productive capacity of the economy on a lower and shallower trajectory than the one that seemed to be in place prior to 2007. Using a version of an unobserved components model introduced by Fleischman and Roberts, we estimate that potential GDP in late 2014 was about 7 percent below the trajectory it appeared to be on prior to 2007. We argue that a significant portion of the recent damage to the supply side of the economy plausibly was endogenous to the weakness in aggregate demand. Endogeneity of supply with respect to demand provides a strong motivation for a vigorous policy response to a weakening in aggregate demand, and we present optimal-control simulations showing how monetary policy might respond to such endogeneity in the absence of other considerations. We then discuss how other considerations—such as increased risks of financial instability or inflation instability—could cause policymakers to exercise restraint in their response to cyclical weakness.
ISSN:2041-4161
2041-417X
DOI:10.1057/imfer.2015.1