The Output Gap Continues; The Impact Of Deficit-Hawks

The difference between "no longer getting worse" and "actually returning to normal":

We stopped getting worse. We still need a serious boost -- like from reversing the austerity of recent budget years -- to get back to good. Alternatively, a large enough boost to EITC could be another way of doing that while at the same time helping mitigate our ever-rising inequality.

Speaking of the recent austerity, here's that in a picture:

Had we not implemented such budget-cutting, deficit-hawk, austerity from 2010 (by not increasing spending commensurate with population growth) and even worse after (by actually reducing government consumption expenditures and gross investment), that alone would have at least had us significantly closer to potential by now. In other words, we'd have had more of a recovery.

Fiscal Conservatism And Necessity

We're in a depression. To many, that's stating the obvious. But it seems not quite everyone realizes just yet.

GDP depressed below normal levels from 2008 through this writing

Our commerce has been significantly below capacity for several years. By the end of 2008 the quarterly output gap exceeded even the previous record (from 1982) for output gaps since 1949. We've seen the main characteristic factors of depression beyond just the raw output gap: increased unemployment, tight credit for consumers and small business, and bank failures (though many of the potential failures were averted). And as anyone familiar with Irving Fisher's work should know, we'd surely have had significant deflation from the paying down of private debts were it not for a series of Fed actions to mitigate deflationary forces.

Deficit hawks ignore the reasons for our deficits in recent years. Depressions increase short-term costs. People out of work utilize the safety net when they wouldn't otherwise. We have a severe short-term increase in costs. At the same time, depressions also reduce revenue. We bring in less tax money because fewer people are getting paid, and often smaller real wages.

There's one clear answer to get rid of deficits: get people back to work. Rev up the economy back to potential. Close the output gap. Until we do that, we'll continue to have increased costs and reduced revenues.

In our attempts to close that output gap, today's fiscal conservatives hamstring us with massive state budget cuts to avoid the temporary tax increases and/or bond issuance needed for dealing with the downturn. Their unwillingness to raise revenue means lots of layoffs, slowing down our economy while hurting the quality of services that we the people want. Many of us would willingly pay more in taxes to keep quality of service through an economic downturn. Many of us would be more than willing to pay more in taxes to keep investing in the sort of growth-spurring government measures that can get us back to expansion. But fiscal conservatives will brook no such sensibility. So instead we get slower growth and less prosperity. Like our slow recovery? Thank a fiscal conservative. Like our rising tuition costs for students? Thank a fiscal conservative. Like our broken roads increasing business costs? Thank a fiscal conservative. Like fewer research patents being licensed to domestic businesses than we'd otherwise have over the coming years? Thank a conservative.

This impact is nothing new. We had deficit hawks and credit growth hawks to thank for the recession of 1937-38 when attempts to balance the budget and tighten monetary policy put a crimp in recovery from the Great Depression. We had sharp cuts in the name of balanced budget zeal to thank for the recessions and increased unemployment under Eisenhower. Time and again, we keep having to re-learn the lesson that sharp cuts hurt even when they're earnestly meant to help.

We're long overdue to stop letting fiscal conservatives shape the narrative. We need to stop worrying about balancing the budget when we're in the midst of a downturn. When the economy's roaring at full steam, then we can afford to mess about with budget balancing. Until then, we can't afford their cuts.

One needs to already be in good shape to recover from a deep, large, sharp cut. Until we've eliminated the output gap, we need more recovery efforts ... not more cuts.

The "Burden of Debt" versus the Burden of a Weak Economy

Dean Baker from "Brad Delong Beats Me To Responding to Nick Rowe":

"... The burden of the debt only exists if there is reason to believe that debt is somehow displacing investment in private capital, which is certainly not true at present. 

I would probably argue the case even more strongly. In a depressed economy like we have today, there is reason to believe that the deficit, by boosting demand, is actually increasing investment, thereby making future generations wealthier. There is also the issue of human capital, that by keeping workers employed and keeping families intact, it is improving the productive capacities of the labor force in the future. 

Perhaps most importantly,it is essential that people understand that the measure of the burden of the debt in future generations is not the size of the debt, but the extent to which we believe the debt has reduced output in the future compared to a counter-factual where we did not run the debt. If the debt did not reduce the economies' future productive capabilities (or even raised them) then there is no burden of the debt. In any case, how well we are treating our children is measured first and foremost by the health and the economy and the society we pass on to them, not the amount of government debt."

(Emphasis added by me)

This is part of why it makes sense to put deficit spending into fixing the output gap. While the economy is rolling, it's rolling slower than it ought to be. If we use deficit spending to push our economy up to its potential, we pass on a more healthy economy to our children.

(For other related comments, see Mark Thoma's "Bogus Arguments about the Burden of the Debt")

And the reverse also holds. In a depressed economy, austerity should shrink what we're handing to our children. Apparently the IMF is starting to learn that lesson about Europe, though as Krugman points out, the GOP seems not to have caught on to the lesson.

Real GDP, the Past Eight Years, and the Years To Come

Real GDP for the past 8 years:

Whatever else one may or may not read into this chart, it sure doesn't help the case for those who would say we should change ships back to the party of Bush II.

Of course, if one adds in potential GDP, essentially where the GDP ought to be right now if we were going to be back to "normal", we're clearly not done. It's roughly like we're going 45 in a 55 MPH zone. There's some serious work to be done to get the economy up to speed. So why has the debate been about how much to raise our foot off the pedal instead of how much further to press down?

The Economic Engine: Is It Fixed?

If our car had a busted transmission, we base whether to call it fixed by how it responds when it's in drive and we press on the gas. Does it go forward when we apply gas? Does it go faster when we apply more gas? If so, then it's fixed ... even when it happens to be going slower on the on-ramp than it was when the transmission first broke on the highway.

We don't base whether to call it fixed on its speed at the moment or how full its gas tank is. That'd be ridiculous.

Right now the Republican House is pulling back on our foot ... keeping us from putting the pedal to the metal. The Fed Chairman filled the tank with monetary measures. The President didn't even try to floor it, but he's tried to apply a bit more gas than the current House is letting him apply with fiscal measures. The 111th Congress was applying more gas than the 112th Congress is applying.

We could be going faster if we applied more gas. That we're not putting the pedal to the metal doesn't mean the car isn't fixed.

Given the output gap between actual and potential GDP, we're driving below the speed limit. The potential GDP is the speed limit. Any faster than that and we're liable to be pulled over and get a ticket. But we could be going faster. There's a good bit of room to step on the gas and get ourselves up to speed. That would require the House to stop holding us back from applying the gas it'd take to get up to speed.