By*: Dylan Steelman, Samuel Ellenbogen, Scott Frank and Steve Bodenheimer
In his May 2011 column, “Is There Really an Output Gap,” CNBC financial blogger John Carney argues that the output gap—the difference between the economy’s potential performance and its actual performance—is a flawed theoretical construct that policymakers should avoid using as a basis for economic policy. Carney presents most of this through a “thought experiment” involving a hypothetical tobacco-based U.S. economy called Tobacco America. In the thought experiment, demand for tobacco explodes driving up prices for various tobacco inputs and taking the economy to new heights. Eventually the dangerous health aspects of tobacco become widely known and the demand for tobacco plummets, taking the economy down with it. Carney uses the Tobacco America thought experiment to make two arguments against the concept of an output gap—one is stated directly and the other is strongly implied.