Tim Bond of Barclays Capital has looked back through the American data since the mid-1960s. he points out that the difference between GDP as first reported (and therefore known to policymakers) and GDP (as subsequently revised) was around 1.4%. That is greater than the average level of the estimated output gap over this period.
As an example, policymakers thought that American GDP dipped 7.7% in the 1974-1975 recession; in retrospect, the decline was only 2.5%. No surprise then that the Fed eased monetary policy by too much and the result was high inflation.
Bond's conclusion is that, given the shock they have suffered, policymakers may end up overestimating the output gap, keeping policy too loose for too long, and tipping us more towards inflation than deflation.
Update: Ezra Klein writes:
At some point, however, the Fed going to need to raise rates. It's going to need to decide when reflation has given way to inflation. And that's what the argument over inflation is actually about. Not whether we're there now, but whether we can trust the Fed to know when we've gotten there, or whether it's going to be listening to the wrong people along the way.
Yup. I'm with Ezra on joblessness being a graver concern than inflation right now. But the interesting thing about Bond's finding, if it's accurate, is that it doesn't matter who you're listening to if the data is wrong. And our best data about output can be misleading, or even wrong.
Yet another example of why it's such a GREAT idea to leave the price fixing of money and credit in the hands of a small group of insulated academics. The question should not be whether they'll get it wrong, but rather, how wrong they'll get it.
How much evidence do we need to acknowledge we're at the mercy of a system that suffers from the "fatal conceit" of believing in the efficacy of non-market calculation? Why should anybody think mainstream economics credible when such obviously flawed thinking, deconstructed by F.A. Hayek and others over 75 years ago, remains the modus operandi of the western financial system?
This comes up recession after recession and in country after country. The reality is that the initial estimates of GNP are normally wrong; and the best the statisticians can do is try to make them equaly likely to be too high as too low. Even that is difficult.
The other half of the prblem for the economic policy makers is that the key decisions for monetary and fiscal policy are taken in the light of the difference between this uncertain estimate and an estimate of the trend level of productive capacity in the economy. That trend level is a good deal more uncertain than the initial GDP estimates. Errors of policy from mis-estimating the trend are at least as serious as those from mis-estimating GDP; but they get much less noticed. Why? because it often takes a decade to demonstrate that we got the trend wrong; and even then there is no conclusive final calculation of it to prove how wrong it was.
There probably is, now, a better way to approach these decisions. It involves fittng the estimates into a model that is better at showing where the serious imbalances in the economy are likely to be if those estimates are right. That gives a better feeling for what is wrong with the estimates. For anyone intereted, the clearest exposition of these stock-flow constrained (sorry for the jargon) models is in Monetary Economics by Godley and Lavoie.
Actually, the problem here is confusing a construct with reality, a classic rookie mistake in which a grad students should have been schooled.
GDP is an idea, a concept, a hypothetical notion based on several layers of ideas and connection and a major assumption that there actually is something like total economic activity. But there really isn't any hard real number. Its all estimates.