What is the GDP Gap?
By Arnold Kling
the difference between the economy’s actual and potential output will average 7 percent of GDP (which is equivalent to about a trillion dollars) this year and next, and that gap in output will not close until 2013.
In macroeconomics, economists act as if we all produce one good called GDP. When we don’t produce as much as economists think we could with full employment, we call this the GDP gap.
But what does it mean in a multi-good economy? To close the GDP gap, should we go back to producing millions of houses to be bought by speculators and financed by hundreds of billions in junk mortgages?
If I were reconstructing macroeconomics, I would describe this as a resource reallocation problem. It combines permanent reallocation and temporary reallocation. That is, some workers need to leave housing construction forever (relative to peak production) and some need to leave only for a while (because we need unusually low production for a while to work off the excess). Output appeared to be higher before the need for reallocation. And after reallocation is finished output will be higher. Meanwhile, output will not be so high, but calling that a “gap” makes it sound as if there ought to be no friction at all in the reallocation process.