Saturday, November 9, 2013

How Badly Has The US Economy's Potential Been Damaged?

John Cassidy picks up on a report that was presented at the IMF's annual research conference.  Paul Krugman briefly summarized the report that I posted a few days ago.  Cassidy goes into more detail on the question raised in the report.  We know that the recession, and our response to it,  caused our economic growth rate to deviate well below our long term growth trend.  According to the report some of the damage to our economy will linger for some time and keep our economic growth rate well below its historical trend.  This raises a deeper question that many economists have been discussing for some time.  Some economists, like Krugman, argue that economy would have recovered fine if government had done the right things during the recession.  That is, government inaction caused the damage to the economy and that we will get back on our trend line over time.  Other economists wonder if the US economy was in bad shape prior to recession and that we should not expect the economy to maintain its historical growth rate.  They argue that the growth rate was maintained by government actions which promoted the bubble, and the real estate bubble.  That is, asset bubbles were responsible for keeping the economy on its long term trend line prior to the recession.  In other words, we should not expect the economy to return to its long term rate of growth in the future.  We should more realistically expect a much lower future growth rate

This is an important question.  If the economy grows at 1.5% instead of 2.5-3.0%, government tax revenues will fall and government spending will have to be dramatically reduced.  This will exacerbate the political issues that we are currently facing in the US.  A rising economic tide covers up a lot of problems that are exposed by a low tide.  We can look forward to increased government dysfunction and turmoil if we are forced to deal with deeper economic problems in the future.

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