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

84 Pages Posted: 9 Jan 2014

See all articles by David Reifschneider

David Reifschneider

Federal Reserve Board - Division of Research and Statistics

William Wascher

Board of Governors of the Federal Reserve System - Division of Research and Statistics

David W. Wilcox

Federal Reserve Board - Division of Research and Statistics

Date Written: November 5, 2013

Abstract

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 (2011), we estimate that potential GDP is currently about 7 percent below the trajectory it appeared to be on prior to 2007. We also examine the recent performance of the labor market. While the available indicators are still inconclusive, some indicators suggest that hysteresis should be a more present concern now than it has been during previous periods of economic recovery in the United States. We go on to 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 -- contrary to the conventional view that policymakers must simply accommodate themselves to aggregate supply conditions. 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.

Keywords: Aggregate supply, structural unemployment, trend productivity, hysteresis in labor markets, aggregate demand, monetary policy, financial crisis

JEL Classification: E17, E24, E32, E52, E61

Suggested Citation

Reifschneider, David and Wascher, William and Wilcox, David W., Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy (November 5, 2013). FEDS Working Paper No. 2013-77. Available at SSRN: https://ssrn.com/abstract=2376334 or http://dx.doi.org/10.2139/ssrn.2376334

David Reifschneider

Federal Reserve Board - Division of Research and Statistics ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-452-2941 (Phone)

William Wascher (Contact Author)

Board of Governors of the Federal Reserve System - Division of Research and Statistics ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-452-2812 (Phone)
202-452-3819 (Fax)

David W. Wilcox

Federal Reserve Board - Division of Research and Statistics ( email )

20th and C Streets, NW
Mailstop 153
Washington, DC 20551
United States

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