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Friday, January 09, 2009

Paul Krugman: The Obama Gap

Is the incoming administration's proposed economic recovery plan large enough to get the job done?:

The Obama Gap, by Paul Krugman, Commentary, NY Times: “I don’t believe it’s too late to change course, but it will be if we don’t take dramatic action as soon as possible. If nothing is done, this recession could linger for years.”

So declared President-elect Barack Obama on Thursday... He’s right. This is the most dangerous economic crisis since the Great Depression, and it could all too easily turn into a prolonged slump.

But Mr. Obama’s prescription doesn’t live up to his diagnosis. The economic plan he’s offering ... falls well short of what’s needed. ...

Earlier this week, the Congressional Budget Office came out with its latest analysis of the budget and economic outlook. The budget office says that in the absence of a stimulus plan, the unemployment rate would rise above 9 percent by early 2010, and stay high for years to come. Grim as this projection is, by the way, it’s actually optimistic compared with some independent forecasts. ...

[T]he C.B.O. says ... that “economic output over the next two years will average 6.8 percent below its potential.” This translates into $2.1 trillion of lost production. “Our economy could fall $1 trillion short of its full capacity,” declared Mr. Obama on Thursday. Well, he was actually understating things.

To close a gap of more than $2 trillion — possibly a lot more... — Mr. Obama offers a $775 billion plan. And that’s not enough.

Now, fiscal stimulus can sometimes have a “multiplier” effect... Standard estimates suggest that a dollar of public spending raises G.D.P. by around $1.50.

But only about 60 percent of the Obama plan consists of public spending. The rest consists of tax cuts — and many economists are skeptical about how much these tax cuts, especially the tax breaks for business, will actually do to boost spending. ... Howard Gleckman of the nonpartisan Tax Policy Center summed it up in the title of a recent blog posting: “lots of buck, not much bang.”

The bottom line is that the Obama plan is unlikely to close more than half of the looming output gap, and could easily end up doing less than a third of the job.

Why isn’t Mr. Obama trying to do more?

Is the plan being limited by fear of debt? There are dangers associated with large-scale government borrowing... But it would be even more dangerous to fall short in rescuing the economy. The president-elect spoke eloquently and accurately ... about the consequences of failing to act — there’s a real risk that we’ll slide into a prolonged, Japanese-style deflationary trap — but the consequences of failing to act adequately aren’t much better.

Is the plan being limited by a lack of spending opportunities? There are only a limited number of “shovel-ready” public investment projects... But there are other forms of public spending, especially on health care, that could do good while aiding the economy in its hour of need.

Or is the plan being limited by political caution? Press reports ... indicated that Obama aides were anxious to keep the final price tag on the plan below the politically sensitive trillion-dollar mark. There also have been suggestions that the plan’s inclusion of large business tax cuts, which ... will do little for the economy, is an attempt to win Republican votes...

Whatever the explanation, the Obama plan just doesn’t look adequate to the economy’s need. To be sure, a third of a loaf is better than none. But right now we seem to be facing two major economic gaps: the gap between the economy’s potential and its likely performance, and the gap between Mr. Obama’s stern economic rhetoric and his somewhat disappointing economic plan.

    Posted by on Friday, January 9, 2009 at 12:33 AM in Economics, Fiscal Policy, Politics | Permalink  TrackBack (0)  Comments (105)

          

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