Research Team at Goldman Sachs, suggests that in recent years, economic forecasters have been too optimistic about GDP growth but too pessimistic about employment across many advanced economies. Key Quotes “To better understand this puzzle, we construct a new supply side model for the US, the Euro area, Japan, and the UK. Building on work done at the major central banks, we use a largely unified framework that nevertheless allows for a few country-specific differences. These include the role of broad labor market slack as measured by the U6 underemployment rate in the US, structural changes related to the introduction of the Euro and Bank of England independence, and imperfect anchoring of inflation expectations in Japan. We find that potential real GDP growth during the post-crisis period has averaged around 1% in the US and Europe, and zero in Japan. As a result of this weakness, even the modest GDP growth rates of recent years have pushed the output gap to 1% or less everywhere except in the Euro area, where our estimate is around 3½%. According to our model, part of the recent weakness is due to one-off hits to the level of potential GDP, which may reflect supply-side damage from the financial crisis or “hysteresis” effects from a prolonged period of resource underutilization. Some of it may also reflect increased understatement of technological progress, as we have argued elsewhere, although our model cannot shed any new light on this issue. Assuming these one-off hits are truly one-off, potential growth should pick up modestly in coming years. But with output and employment already close to potential in the US and the UK, inflation is likely to rise more than bond markets currently discount.” For more information, read our latest forex news.