In the last post, I did a regression for real GDP in relation to potential GDP. The adjusted R squared was 85% and the graph looked like this. (Orange line is official CBO real GDP - potential real GDP. Blue line was my regression based on capacity utilization, labor share index and monetary policy.)

Now I change the regression by taking out my measure of monetary policy and replacing it with the unemployment rate. Here is the report of the regression.

SUMMARY OUTPUT | ||||||

Regression Statistics | ||||||

Multiple R | 0.95 | |||||

R Square | 0.90 | |||||

Adjusted R Square | 0.90 | |||||

Standard Error | 50.45 | |||||

Observations | 108 | |||||

ANOVA | ||||||

df | SS | MS | F | Significance F | ||

Regression | 3 | 2452450 | 817483.4 | 321.21 | 1.99E-52 | |

Residual | 104 | 264682.6 | 2545.02 | |||

Total | 107 | 2717133 | ||||

Coefficients | Standard Error | t Stat | P-value | Lower 95% | Upper 95% | |

Intercept | -829.32 | 237.82 | -3.49 | 0.000717 | -1300.9 | -357.7 |

TCU | 23.37 | 2.20 | 10.63 | 2.62E-18 | 19.0 | 27.7 |

LSI | -8.12 | 2.25 | -3.61 | 0.00048 | -12.6 | -3.7 |

UNRATE | -41.84 | 5.14 | -8.14 | 8.93E-13 | -52.0 | -31.7 |

The adjusted R squared has risen to 90%. The equation for the regression is...

Real GDP - potential real GDP = 23.37*capacity utilization - 8.12*Labor share index - 41.84*unemployment rate - 829.32

The graph looks like this... (I have highlighted the times periods that were used to make the regression.

This blue line is a better fit. It shows more stability in the late 1990's with real GDP consistently a bit over potential. Real GDP was a bit over potential before the crisis. And now it shows that real GDP hit potential in 2014 with the quick drop in unemployment.

This new regression would explain why the US economy has been doing well over the past year, since real GDP has reached potential. The regression also implies that there is not much slack remaining.

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