Ditch this daft concept and expose economists to reality During my 20-year working life, Britain's economy has operated under five separate economic frameworks. The authorities have declared each a triumph until it was discarded. In the European exchange rate mechanism days, before Black Wednesday in 1992, the Treasury sought to anchor inflation by pegging sterling to the Deutschmark. Then the government replaced the exchange rate anchor with an explicit inflation target. In 1997 the Labour party made the Bank of England independent, gave it operational responsibility for monetary policy and constrained its own discretion with new budgetary rules. Once these rules blew apart in 2008, the government tried monetary independence without fiscal rules. And after 2010, the coalition government is putting in place monetary policy independence, system-wide financial regulation and new fiscal rules underpinned by independent economic forecasts. Each framework has evolved from its predecessor and, for nearly 20 years, each has also relied on an "output gap" concept. The output gap is the difference between actual output and its potential. Theory suggests that if the level of output is higher than potential, inflationary pressures are set loose and monetary policy should be tightened. In contrast, inflation will fall in periods of weakness so policy should be relaxed. For fiscal policy, the details have changed but each framework has roughly sought a position of sustainability when the output gap is zero. The output gap is conceptually neat and aids thinking. The fatal flaw is that, in practice, it creates the appearance of precision when the reality is ignorance. Measuring output is difficult enough in a modern economy. Distinguishing changes in the value of many services from changes in their volume is even harder. It is impossible to know the sustainable volume of goods and services that the economy can produce. Economists have always known the output gap cannot be measured but many insist they have to take a view to set policy. Taking decisions under uncertainty is the fate of policy makers and economists. The question is whether estimating output gaps helps the process. It might if these estimates were stable. They are not. In 2007, for example, almost all estimates of the output gap were close to zero. Now, the OECD estimates that Britain's economy was wildly unsustainable in 2007, running 4.4 per cent hotter than needed, on the reasonable basis that the 2007 economy was entirely unsustainable. If we now know that an answer to too much spending in 2007 was less spending, we did not know it at the time; our standard temperature gauges for the output gap - inflation and wage inflation - showed few signs of distress. At the centre of economic policy we therefore have a concept that cannot be measured, one whose estimates are subject to massive revisions and one that has an extremely tenuous relationship to concurrent proxies. It is useless. Ditching the output gap concept would not resolve the big economic debates of the day but it would at least free them from some unnecessary constraints. Monetary policy makers would no longer have to act so surprised that inflation has remained stubbornly high alongside economic weakness. In fiscal policy, the authorities would have to accept that they do not know how much of the deficit is structural and needs action, and how much will go away as the economy recovers. The consequence would be more honest policy based on broad rules of thumb. Targets for nominal gross domestic product growth make sense in this world. So does setting public expenditure plans and the taxation system to stabilise government debt levels consistent with such growth. And there is the need to scan the horizon for unsustainable elements in the financial system. None of these is very different from the policies practised today but they demonstrate policy makers" lack of knowledge and the likely interlinkages between monetary, fiscal and macro-prudential policy. Such a world would strip policy makers and economists of layers of theoretical argument, leaving them quite naked. Better that than deceiving themselves, emperor-like, that they wear finely woven cloaks of policy wrapped around a measurable output gap.