Chad Stone is chief economist at the Center on Budget and Policy Priorities.
The economy has been moving in the right direction for two and a half years, but so slowly that the Congressional Budget Office says in its latest Budget and Economic Outlook that "the economy remains in a severe slump" and will not be back to operating on all cylinders until the first half of 2018. Is that the best we can do?
Here's the situation according to mainstream economic analysis, including that of the CBO and the Federal Reserve: demand for goods and services, which tanked in the Great Recession, continues to be far below what the economy is capable of producing with our available labor force, factories and machines. As the chart shows, recent growth has not been fast enough to narrow the gap between actual GDP (the output we are producing to meet weak actual demand) and potential GDP (the output we could produce without generating inflation if demand were strong enough).
To close the gap between actual and potential GDP, the former has to grow at a faster pace than the latter for some period of time. Current projections by CBO, the Federal Reserve and private forecasters expect this to happen very gradually.
Slowly closing the output gap is costly. The CBO estimates that the cumulative output gap from 2008 through 2017 will total nearly $6 trillion. That's output that doesn't get produced and incomes that don't get earned, which are then lost forever. Moreover, as the CBO observes:
Not only are the costs associated with the output gap immense, but they are also borne unevenly. Those costs fall disproportionately on people who lose their jobs, who are displaced from their homes, and who own businesses that fail.
In addition, long periods of excess unemployment take their toll on potential GDP as discouraged workers permanently drop out of the labor force and skills atrophy as workers are unemployed. In a protracted slump, subdued levels of investment in new plants, equipment and research and development also slow the growth of potential.
The common lament about this sluggish recovery seems to be: "That's just the way it is," following recessions caused by a financial crisis. But maybe that's just the way it's been because policy makers have not responded aggressively enough to the effects of financial shocks on aggregate demand.
In its report, the CBO shows that under an alternative fiscal scenario with tax cuts and additional spending, the economy can perform better in the short run, with faster growth, lower unemployment and a smaller output gap.
To be sure, the CBO's particular alternative scenario would increase the long-term budget deficit, which would hurt long term growth. But as I wrote last week, the really smart policy is to enact one set of measures that gives the economic recovery a boost in the short term and another that brings down the deficit starting once the economy is stronger.