Thursday, April 28, 2011

What this recovery has taught us

This chart compares the long-term trend growth of real GDP to actual GDP, with today's Q1/11 GDP release included. What jumps out from the chart is the fact that the economy's level of output has been about 10% below its long-term "potential" output for more than two years. This is the biggest growth shortfall since the Depression, and it has persisted for more than two years despite unprecedented levels of fiscal and monetary stimulus.

Die-hard Keynesians are still unwilling to accept that stimulus has failed, and some, like Paul Krugman, still argue that the problem was that the stimulus wasn't big enough. But as I predicted in a post in January 2009, the fiscal stimulus package championed by Obama and the Democrats would prove to be a significant drag on growth, and I think the evidence now supports my prediction. You can't create growth out of thin air, or by transferring money from one person to another by government fiat. When government commandeers a big chunk of the economy's resources, as it did beginning two years ago, those resources end up being spent in a much less efficient fashion than if they had been left in the private sector. The result is slower growth. We're in a recovery, but it's a very slow recovery because government is smothering the economy.

Morever, with trillion-dollar deficits staring us in the face for as far as the eye can see, market participants, workers, and business owners can't help but fear an eventual and substantial rise in future tax burdens. Just the possibility that future tax burdens could rise meaningfully is enough to reduce the discounted, after-tax, present value of future cash flows, and to discourage, on the margin, new investments.

Monetary policy is also culpable. By adopting an unprecedented quantitative easing program, and promising repeatedly to keep short-term rates very low for an extended period, the Fed has introduced a significant amount of monetary uncertainty into the financial markets and the economy. Inflation expectations are rising, and the dollar has fallen to all-time lows, as capital decides that the U.S. economy is not a very attractive place to be. Treasury yields are still very low, despite our massive budget deficit, because an excess of spending is depressing the economy and depressing the expected returns on alternative investments.

So the lesson from this tepid recovery is that the more government tries to "stimulate" the economy, the worse things will be. If Washington and the American people can take this lesson to heart, then the pain and suffering of this slow-growth recovery will not have been in vain. This could end up being the best thing to have happened for the economic outlook since the early 1980s.


Frozen in the North said...

Then the solution must be: Do nothing, except maybe remove regulation and barriers to businesses!


Of course even Krugman didn't think that unemployment benefits will provide the uplift to the economy, it was to be a floor (maybe). However, income in America are falling, daily cost of living are rising (food & energy). There is a bubble out there, its called the stock market. Thankfully, most Americans are not exposed to that one, since they have no savings nor (apparently) pension plans.

Bill said...

Isn't the drag on GDP increased imports? If imports weren't subtracted, wouldn't the GDP number show a much more robust recovery?

TradingStrategyLetter - Weekly Summary said...

You'd get my vote as Fed Head!

brodero said...

Oh wouldn't it have been nice to have the 800 billion we spent towards the War in Iraq ( an expense conveniently forgotten
as we pillory the banks and the Fed)

NormanB said...

Krugman's contention that the stimuless wasn't big enough is a congential defect in liberal thinking. They start out with a philosphy, implement action and then when it doesn't work or worse yet, when the policy action produces an actual negative result their prescription is to do more of it otherwise they'd have to admit that their philosphy was wrong. Can't do that.

The Libs did the same thing with the War on Poverty. As the African-American community got beaten into the ground (illegimate children, men in jail, uneducated, etc) they wanted to do more of the same stupid thing.

And if Krugman was so smart how come he hasn't come to the aid of the NYT? By the way, the NYT has a total capitalization of about $1.5B yet the Huffington Post sold for $3.0B.

Those damn facts.

randy said...

Could have created a lot of natural gas infrastructure for autos for 800 billion. But Iraq had nothing to do with oil... all of our defense and foreign policy is all about freedom and the American way.

Bill said...

The Left always doubles down on stupidity and failure as their ideology is an emotion based one of equality at all costs. Motive to them matter more than results.

brodero said...

Afghanistan Yes...Iraq No....a
monumental mistake that resembles
what the British did before their
empire crumbled...

Matt Busigin said...

First point:

A Superior Output Gap Chart

The output gap has not been 10%. It was just above 7% at peak. It is also eclipsed by the output gap of the early 80s, which was above 8%.

It is also absurd to think that the government is in the way of recovery with such a large output gap.

There is no contention for investment capital (the Fed's monetary policy has successfully addressed this, which is why venture & angel funding is not only better than it was pre-recession, but at pre-2000 level). Returns on investments/profit margins are at all-time near-peak levels, so the climate is not bubbly - it's great for business.

There is no contention for employees (as evidenced by the 7 million workers from peak.

You could make the argument that there is far less slack in the resource market, but two critical points:

1) The commodity tightness is a result of global demand, which would eat any slack in US demand.

2) Monetary policy may only directly be blamed for the low interest rates, and consequently low cost to carry forward futures contracts. There is no doubt that there is somewhat of a speculative premium, but given the calendar spreads, even a rich estimate of a 10% premium is not meaningfully a drag on economic growth.

3) Commodity inputs are miniscule in comparison to end prices.

Matt Busigin (Macrofugue)

Matt Busigin said...

One final comment (sorry!) -- I don't think fear of taxation is holding back a single economic activity.

I will of course concede that there may be a one-time improvement by normalising our corporate tax rates to repatriate some capital & business in this country.

NOBODY domestically, however, is holding back building a factory or starting a business because of this fear. On the contrary, the margins are as fat as they almost ever have been, so the high returns on capital have produced the best and juiciest business conditions in some time.

Scott Grannis said...

Matt: you are making some heroic assumptions. Do you really believe that no one's behavior is influenced by taxes or by expectations of changing tax rates? There is plenty of data to prove you wrong.

Matt Busigin said...

I am not assuming that no-one's behaviour would change; I am saying that there is little expectation or behaviour change now.

Scott Grannis said...

I would argue that the 25% increase in government spending as a % of GDP has almost certainly raised fears of a corresponding, and significant, increase in future tax burdens. How could it be otherwise?

Matt Busigin said...


Federal receipts haven't funded federal expenditures for 40 years. Why start now?

TradingStrategyLetter - Weekly Summary said...

Great work Scott. U r #1