• Home
• Personal Finance
• Economy
• New School
• Asked & Answered

• ABOUT
• FAQ
• RESOURCES
• ADVERTISE
• CONTACT

A Huge Gap

We have a trillion dollar output gap - that is the difference between potential Gross Domestic Product (GDP) and actual GDP.  This is quite significant and the question is what are we going to do about it? 

Check this graph out:

Source: Why is the unemployment rate so high, and does it fully capture labor market weakness? (January 2010)

Wow, that sure is an eye-opener.  BTW, those gray bars indicate recessions - notice the width of the gray bar showing our current Great Recession. 

So where is the ‘economic stimulus’ going to come from to close this gap and put us on the road to recovery?  There are a limited number of segments of the economy that can do it: consumers, private investment, government spending and/or net exports.  That’s it.

Consumer - Us. We. Our purchases (or consumption) make up well over 70% of GDP.  But, we have serious issues:

- We lack confidence to consume as exhibited by the University of Michigan Consumer Sentiment:

Why do we lack the confidence to to consume?  One very big factor and one smaller one.

- Big factor:  high unemployment - 10.4% and the much broader measure of unemployment - 16.8%.

- Small factor: Debt - many of us are still paying down our debt (very smart thing to do) so that obviously means less money to consume.  Here is the most recent graph showing household debt service to disposable income:

Private Investment - Private investment is purchases of fixed assets (equipment, software, and structures) by private businesses that contribute to production and have a useful life of more than one year, purchases of homes by families, and private business investment in inventories.  Let’s look at a graph of Private Investment:

Looks like it hit bottom - maybe.  There is a lot talk in business/economic circles of an “inventory bounce”.  This is where businesses that sold off or written off inventory during recession start to rebuild inventory and possible hire more people because of it.  The problem is that an “inventory bounce” if it does happen is a one-time event.  But there are serious questions as to whether we are experiencing an “inventory bounce”.

Growth in this segment depends on us the consumer.  If we are not buying and businesses don’t believe that we will in the future then forget about inventories.  If we are not employed or have jobs then forget about purchase of fixed assets.  BTW, forget about the home purchases.  This won’t save us until the housing market stabilizes. 

Net Exports - This is the difference between exporting of goods and services and the importing of goods and services.  We are a long long way off until U.S. exports lead a recovery.  Net exports is still negative.

Government Spending - Government spending has gotten a bad name some of it deservedly most of it not.  Consumers and businesses have serious constraints on the amount they can contribute to economic growth.  Government, contrary to what we hear from deficit hawks, does not have same constraints.  This doesn’t mean that all government spending and/or tax cuts are good and not wasteful.  It can be very bad and wasteful - just look at how much has been spent on two wars and the bailout of Wall Street, Fannie Mae and Freddie Mac.  We are certainly not any better off because of these government expenditures (actually we are still spending in these areas). 

We had a $787 billion stimulus package back in February 2009.  It did save us from a much worse economic situation but it was too small and poorly designed - too many tax cuts and not enough ‘bang for the buck’ job creating investments.  Now, we have the $18 billion “jobs bill” about to be signed by President Obama but again this bill is poorly designed.  This “jobs bill” provides tax incentives to small businesses that hire new workers - give me a break - businesses hire workers because there is demand or potential demand for products and services not because of some tax incentive. 

Economic stimulus in the form of government spending must come with “overwhelming force” and highly targeted for current and future productive purposes.  We don’t have to struggle with or accept high unemployment now or for the next several years.  There are things we can do now if politicians in Washington had the courage to do so.

As for those who are worried about the deficit.  The current deficit is bad not because government spending is “out of control” but because the economy is bad - it’s the Great Recession.  The following two articles are offered as a response to deficit hawks:

In Defense of Deficits
The Dangers of Deficit Reduction