US Economic Potential May Have Been Reduced By 7% Because Of Recession

Paul Krugman is attending the IMF's annual research conference and he believes that the blockbuster report at the conference will be the Fed's study on lost economic potential in the US.  The study explained how our failure to deal with high unemployment will have lingering effects on the US economy.  The long term unemployed have become unemployable and they are no longer able to contribute to the economy.  That along with other failures in our response to the recession may have reduced the potential output of the US economy by 7%.  That amounts to around $1 trillion of lost annual output for many years.  One of the consequences of lower economic potential is that the "normal" rate of unemployment in the US will rise above the 5-6% number that we associate with a full-employment economy.  We may be at the new normal today in the US with unemployment at 7.3%.

The lost output that we will experience for many years is the result of political failure.  The US political system, along with that of many countries in Europe, decided that budget deficits were a more important problem than high unemployment.  Some countries in Europe may not have had any choice in how they dealt with the recession.  The US did not have to make the choices that it made.