On the subject of “austerity”, Krugman “twists and turns”:
Right now the official unemployment rate is 7.3 percent. That’s bad, and many people — myself included — think it understates the true badness of the situation. On the other hand, there are some reasonable people (like Bob Gordon) arguing that at this point, possibly thanks to long-run damage from the Great Recession, “full employment” is now a number north of 6 percent. So there’s considerable uncertainty about just how depressed we are relative to potential. But we’re clearly still well below potential. And we’ve also had exactly the wrong fiscal policy given that reality plus the zero lower bound on interest rates, with unprecedented austerity. So, how much of our depressed economy can be explained by the bad fiscal policy?
To a first approximation, all of it. By that I mean that to have something that would arguably look like full employment, at this point we wouldn’t need a continuation of actual stimulus; all we’d need is for government spending to have grown normally, instead of shrinking.
Here’s a comparison of two series. One is actual government purchases of goods and services since the Great Recession began (this is at all levels; most of the fall has been state and local, but the Federal government could have prevented that with revenue sharing). The other is what would have happened if those purchases had grown as fast as they did starting in the first quarter of 2001, i.e., in the Bush years. (The chart is a better version of Krugman´s).
As you can see, the gap is large and has been growing rapidly; it’s currently at about 400 billion 2009 dollars, or more than 2 1/2 percent of GDP. Given reasonable multipliers, this suggests that real GDP is somewhere between 3 and 3.75 percent lower than it would have been without the austerity. And given the usual Okun’s Law rule of half a point of unemployment per point of GDP, this in turn says that without the austerity we’d have an unemployment rate well under 6 percent, maybe even under 5.5 percent.
I don’t want to pretend to spurious precision here. Instead, I just want to make the point that given what we know and have learned about macro these past five years — and given the modest recovery that has taken place — we’re now at a point where, to repeat, to a first approximation the depressed state of the economy is entirely due to destructive fiscal policy.
The austerians have a lot to answer for.
It all sounds too good to be true. In particular, Krugman disregards monetary policy completely (we´re, after all, in a liquidity trap).
Below I reproduce my version of Krugman´s chart together with a chart of NGDP & Trend. Note that during the quarters from mid-2008 to mid-2009, while nominal spending tanked, real government spending was growing at an almost “normal” rate. But real growth plunged and unemployment soared. The adoption of QE1 was enough to reverse the spending trend despite the contraction of real government purchases!
Now, imagine if a “regime shift” à la Christy Romer had been implemented in mid-2009, with the Fed´s target being a particular NGDP level. By now I´m pretty confident we would be progressing along the “continuance” path!
So, the answer to Krugman´s question: “So, how much of our depressed economy can be explained by the bad fiscal policy? Is: “To a first approximation, NONE of it”.
Related: “Just one of those things“