TBO.com - TBO is Tampa Bay Online

U.S. Now Facing Two Economic Gaps

ADVERTISEMENT

By PAUL KRUGMAN

New York Times News Service

Published: January 12, 2009

"I don't believe it's too late to change course, but it will be if we don't take dramatic action as soon as possible. If nothing is done, this recession could linger for years."

So declared President-elect Barack Obama on Thursday, explaining why America needs an extremely aggressive government response to the economic downturn.

He's right. This is the most dangerous economic crisis since the Great Depression, and it could all too easily turn into a prolonged slump.

But Obama's prescription doesn't live up to his diagnosis. The economic plan he's offering isn't as strong as his language about the economic threat. In fact, it falls well short of what's needed.

Bear in mind just how big the U.S. economy is. Given sufficient demand for its output, America would produce more than $30 trillion worth of goods and services over the next two years. But with both consumer spending and business investment plunging, a huge gap is opening up between what the U.S. economy can produce and what it's able to sell.

And the Obama plan is nowhere near big enough to fill this "output gap."

Earlier this week, the Congressional Budget Office came out with its latest analysis of the budget and economic outlook. The budget office says that in the absence of a stimulus plan, the unemployment rate would rise above 9 percent by early 2010, and stay high for years to come.

Grim as this projection is, by the way, it's actually optimistic compared with some independent forecasts. Obama himself has been saying that without a stimulus plan, the unemployment rate could go into double digits.

Even the CBO says, however, that "economic output over the next two years will average 6.8 percent below its potential." This translates into $2.1 trillion of lost production. "Our economy could fall $1 trillion short of its full capacity," declared Obama on Thursday. Well, he was actually understating things.

To close a gap of more than $2 trillion - possibly a lot more, if the budget office projections turn out to be too optimistic - Obama offers a $775 billion plan. And that's not enough.

Now, fiscal stimulus can sometimes have a "multiplier" effect: In addition to the direct effects of, say, investment in infrastructure on demand, there can be a further indirect effect as higher incomes lead to higher consumer spending. Standard estimates suggest that a dollar of public spending raises GDP by around $1.50.

But only about 60 percent of the Obama plan consists of public spending. The rest consists of tax cuts, and many economists are skeptical about how much these tax cuts, especially the tax breaks for business, will actually do to boost spending. The bottom line is that the Obama plan is unlikely to close more than half of the looming output gap, and could easily end up doing less than a third of the job.

There are dangers associated with large-scale government borrowing - and this week's CBO report projected a $1.2 trillion deficit for this year.

But it would be even more dangerous to fall short in rescuing the economy. The president-elect spoke eloquently and accurately on Thursday about the consequences of failing to act - there's a real risk that we'll slide into a prolonged, Japanese-style deflationary trap - but the consequences of failing to act adequately aren't much better.

There are only a limited number of "shovel-ready" public investment projects - that is, projects that can be started quickly enough to help the economy in the near term. But there are other forms of public spending, especially on health care, that could do good while aiding the economy in its hour of need.

Whatever the explanation, the Obama plan just doesn't look adequate to the economy's need. To be sure, a third of a loaf is better than none. But right now, we seem to be facing two major economic gaps: the gap between the economy's potential and its likely performance, and the gap between Obama's stern economic rhetoric and his somewhat disappointing economic plan.

Paul Krugman is a columnist for The New York Times.

Share this:

Loading Comments...

Email Print

ADVERTISEMENT