Fed's Bullard: US output potential may have shrunk

WASHINGTON Tue Feb 14, 2012 4:04pm EST

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WASHINGTON Feb 14 (Reuters) - The U.S. economy's productive capacity may not be as great as generally believed, a top Federal Reserve official said on Tuesday, suggesting the recovery may not have that far to run to reach its potential.

The standard view of the "output gap" holds that the economy would have to recover at a growth rate above its long-run potential to catch up to where it would have been if production had not fallen off during the 2007-2009 recession.

U.S. gross domestic product would need to expand by 6 percent for the economy to close the gap between the current level of output and where it would have been if it had dodged recession and continued to grow at what many view as a trend-like rate; at a 3 percent growth rate, the gap would not close until 2020.

That view, however, may overstate how fast the economy can grow without generating troubling imbalances, and it could potentially inflate another asset bubble, James Bullard, president of the St. Louis Federal Reserve Bank, said in response to an Internet blog post.

Economic growth before the recession was skewed by the mistaken belief that house prices would continue to rise, leading to an over-stated view of trend growth, he warned.

"Actual output was higher than properly defined potential during the mid-2000s, and then it crashed back as the bubble burst," Bullard said.

Also, the economy's potential likely varies over time in response to shocks and should not be projected to increase smoothly and steadily, he added.

The remarks by Bullard, who is seen as a policy centrist, show why he is likely to push back against arguments within the Fed for more aggressive steps to push the economy to faster rates of growth to make up lost ground. The St. Louis Fed president, who admits that his skepticism regarding the traditional output gap model is not widely held, is not a voter on the Fed's policy-setting panel this year.

Economists and many other Fed officials point to a yawning output gap as justification for the central bank's efforts to spur a stronger recovery.

Bullard's remarks were posted to a blog maintained by University of Oregon economist Mark Thoma. ()

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