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Your 'ED Output Gap' chart is very interesting and it raises a few questions.

If I move the 'Real-Real' graph y axis over to the left side then I get a graph where 'ED Output Gap' more closely matches your graph above.

Before 1990 those two measurements seem to track with each other. When one goes negative, the other goes negative with only a slight possible delay.

After 1990, Real-Real goes negative and stays negative while the ED Output gap goes positive and stays there until about Q3 1998 when their paths actually cross.

What caused 'ED Output Gap' to recover back to positive when the 'Real-Real' gap remained?

Viewed separately, TCU went up and Labor Share actually went down. But what brought that on in the mid 1990s? The shock value of NAFTA becoming law?

Then in Q2 2002, 'Real-Real' peaks positive as 'ED Output Gap' has already began a negative move which will reach peak negative during the 2002 recession. I believe that this is the DOT.com bubble.

The recovery of 'ED Output Gap' began in Q4 2001. But the recovery of 'Real-Real' does not begin until Q1 2003 and only very briefly goes positive in Q1 2006, before going back negative. And 'Real-Real' has stayed negative ever since 2006. I believe that the difference between these two indicators is due to the massively increasing consumer borrowing during the 2000 to 2007 time period. TCU could increase while Labor Share was steadily decreasing. (As long as the housing bubble was growing.)

Then by Q4 2007 the housing bubble popped and the growth in total household debt very quickly faded. (In Q4 2008 total household debt began to decrease.)

'Real-Real' has stayed negative since Q1 2006 and when 'ED Output Gap' turned negative the Great Recession began. (As new total household debt was stalling.)

TCU has been moving negatively since November 2014 and Labor Share has been increasing but it is still low.

The economy is now completely dependent on Labor Share to drive consumer spending and Labor Share has not been growing fast enough. Stating the obvious, the creation of low wage, part time jobs has not been good enough to return our economy to health.

Currently 'Real-Real' has reached a new positive high in Q3 2015 and turned negative again. (While remaining negative overall.) And 'ED Output Gap' had gone negative in Q1 2016.

Combine this with the Industrial Production Index indicating a recession and we have two indications of a recession which began in Q1 2016.

I believe that the government will have to revise their Q1 2016 numbers for the worse. Or they can cook the books.

Hi Jim,
There are two types of "potential". Type 1 is looking at all the labor and capital resources and productivity, then seeing what is greatly potential.
Type 2, my way, is looking at the first type and seeing a limit that will block the economy from reaching that great potential of type 1. Then realistically potential has to exist under that limit of type 2.
There are times in the past when my model would have seen more potential (type 2 greater than type 1). And times when my model would have seen less potential (type 2 less than type 1).

But for most of the data, I have seen type 2 less than type 1 because I see a limit within type 1.

My model shows a much more consistent pattern through the business cycles, which implies that type 1 has a big error in it. It is missing the effective demand limit.


I don't believe we have a disagreement about what 'ED Output Gap' represents.

I am merely noting that when 'ED Output Gap' goes negative it apparently means that a recession is beginning UNLESS 'Real GDP' is about equal or higher than 'Real GDP Potential'.

And those exceptions are probably caused by some unusual economy activity such as the DOT.com bubble or the Housing bubble and the associated debt. Those are probably the times which you say "implies that type 1 has a big error in it." (Money created out of thin air due to increasing debt, and actually spent into the economy.) Of course eventually that debt must be repaid, which reduces money in the economy. That is probably why 'Real GDP' is currently so much lower that 'Real GDP Potential'. That reduction of the money supply or the historically low Velocity or a combination of both.

Another exception could be when the price of oil fell dramatically from about 1980 to about 1986. That was like a tax free increase in consumer income. (Although the FED generated recession in 1981-1982 muddies the waters somewhat.)

But currently, 'Real GDP' is lower than 'Real GDP Potential'. There is nothing putting large sums of money into the economy or into the hands of consumers outside of income.

I hear you... does the most recent data imply an imminent recession? I think within 4 quarters yes, when I look at past patterns.
Income is key. It is the only and best way to put money in the hands of labor consumers.

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Data as of 2ndQ-2017
Effective Demand = $17.222 trillion
Real GDP = $17.011 trillion
Productive Capacity is rising to next business cycle = $23.266 trillion
UT index is falling= +0.9%
Effective demand limit = 74.0%
TFUR = 73.1%
ED Fed rate rule (down from a peak of 3.8% in 2014) = 1.9%
Estimated Natural Real Interest rate = 1.6%
Short-term real interest rate (fallen from 2.8% peak in 2014) = -1.2%

There is no recession for 2ndQ-2017. Chance of recession is growing as economy heads toward 2nd effective demand limit in this business cycle.

Click on Graphs below to see updated data at FRED.

UT Index (measure of slack):

The UT Index



z derivatives in terms of labor & capital:

z derivatives in terms of labor & capital

Effective Demand, real GDP & Potential GDP:

ED, real GDP & pot rGDP

ED Output Gap:

ED Output gap

Corporate profit rate over real cost of money:

Corp profit rate over real cost of money

Exponential decay of Inflation:

Corporate profits impact Inflation

Measures of Inflation:

Measures of Inflation

YoY Employment change:

YoY employment change

Speed of consuming slack: yoy monthly:

Speed of consuming slack

Speed of consuming slack: quarterly:

Speed of consuming slack quarterly

Real consumption per Employee:

real consumption per employee 2

Will real wages ever rise faster than productivity?:

Productivity & Real Wages

Real Wage Index:

real wage index



Productivity against Effective Demand limit:

Prod & ED limit

Bottom of Initial Claims?:

Initial claims

Tracking inflation expectations:

Fisher effect?

M2 velocity still falling:

Measures of Inflation

All in one:

All in one

Double checking labor share with unit labor costs & inflation:

My Photo
Edward Lambert: Independent Researcher on Effective Demand.
Some links for economic analysis
Fed Views - San Francisco Fed, around 10th of each month.
Well's Fargo monthly - around 10th of each month
Well's Fargo weekly
Well's Fargo Interest rate report
Well's Fargo Economic indicators
T. Rowe Price weekly market wrap-up
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