Most of the headlines surrounding the new Congressional Budget Office budget projections released Tuesday focused on what it told us about the deficit. It’s falling! The CBO expects the budget deficit to drop $845 billion in 2013, the lowest in five years.
But forgive me if I’m not popping Champagne. What was a trillion-dollar budget deficit has fallen. But another trillion dollar deficit is actually on the rise.
Here is the bad news, in one gloomy chart:
Potential GDP is the CBO’s best guess of what the U.S. economy is capable of churning out. If almost all the people who wanted a job had one, if factories were running at their capacity, if office building and shopping malls were full, our collective national output would be the dark blue line.
As the graph shows, until the start of 2008, the United States was churning stuff out at about our capacity. Then, of course, a crippling recession struck. The economy didn’t start growing again until 2009. But it’s what happened next—and what the CBO thinks will happen in the next few years—that is really problematic.
Yes, the economy has been growing for the last 3½ years. But the “output gap,” the difference between what we’re capable of producing and what we’re actually producing, hasn’t actually closed. In those 3 ½ years, we have added to the working age population and businesses have found ways to be more productive, so the U.S. economy is producing more stuff than it did at the start of the recovery. But we haven’t closed the gap. In the fourth quarter, the U.S. economy was producing goods at a $15.8 trillion annual rate; but CBO figures that number could have been $16.8 trillion.
Political commentators have made a big deal of the budget deficit falling under $1 trillion for the first time in half a decade. But this is the real trillion dollar deficit: A $1 trillion gap between what America is capable of and what it is actually producing.
It gets worse! The $1.01 trillion output gap is higher than it has been in more than a year. In the third quarter, that gap was only $914 billion (this is the flip side of last week’s disappointing GDP number). In other words, this deficit is getting worse, not better. And under CBO’s projections, it will widen again this year, as the economy grows at something below its potential: What is now a $1 trillion output gap will become a $1.2 trillion output gap, as the economy slows down due to fiscal tightening enacted as part of the 2011 debt ceiling deal and 2012 fiscal cliff deal.
And while estimates of potential output include lots of guesswork and assumptions, it is not as if CBO is blindly assuming that the U.S. economy can continue growing at the same pace forever. The analysts there try to adjust for demographic factors (like more people hitting retirement age) and structural changes to the economy caused by the recession (like workers who are unemployed for long periods of time seeing their skills atrophy). CBO’s estimates have potential GDP rising at only a 1.7 percent annual rate in recent quarters, compared with a a 2.4 percent rate just before the recession.
Add it all up, and this is the scary vision of the economy presented by the CBO data: We had a really bad downturn in 2008-2009. Since then, we’ve been growing, but we haven’t made up the lost ground. Instead, in 2012 and 2013, we are set to lose further ground rather than make it up. And we’re producing below our potential even after adjusting for the fact that our potential was damaged by the recession.
There are some stories that could make the picture rosier. Maybe, if deficit hawks are right, the deficit reduction will unleash new confidence among consumers and businesses, driving growth that will offset the effects of austerity. Maybe the Federal Reserve’s new unconventional easing policies will encourage more growth than their previous efforts. Maybe the underlying forces driving recovery in housing and consumer balance sheets will create enough growth to push growth above its long-term trend.
But if the CBO’s projections turn out to be right, our economy has a huge problem, and it’s getting worse, not better.