People are cheering that the U.S. economy is finally back to operating at its full potential, eight years after the global financial crisis ended. “U.S. Economy Reaches Its Potential Output for First Time in Decade,” the Wall Street Journal headlined its story on Nov. 29. “The crisis is officially over,” Deutsche Bank AG chief international economist Torsten Slok wrote in a Dec. 1 note to clients.
There’s less here than meets the eye, though. The only reason the U.S. economy is operating at its full potential is that its potential is lower than we once thought it would be by now. As Beth Ann Bovino, chief U.S. economist at S&P Global Ratings, told the Journal, “We’ve moved the goal post.”
CONGRESSIONAL BUDGET OFFICE, FEDERAL RESERVE BANK OF ST. LOUIS
This chart makes the point. The red line represents gross domestic product. It just managed to cross the blue line, which is the Congressional Budget Office’s estimate of potential GDP. The crossover means the economy is producing as much output as it can without overheating. The low unemployment rate—4.1 percent in October—is a reflection of that. If output of goods and services were much greater, inflation would be likely to break out.
But look at the black line, which I got from the wonderful Fred database at the Federal Reserve Bank of St. Louis. The black line is what the Congressional Budget Office estimated in 2007 would be the U.S. economy’s potential output by now. It’s $1.7 trillion higher than the red line. That’s the gap between where we are now and where, a decade ago, we thought we would be by now. (I’ve stated all numbers in 2009 dollars.)
Economists disagree over why potential GDP is so much lower now. Some argue that the CBO was too optimistic back then, others that it’s too pessimistic now. Some say that the financial crisis itself did lasting harm to the economy—some workers who lost their jobs never came back, reducing the economy’s productive capacity. Harvard economist Lawrence Summers argues that the world is in the grip of a prolonged “secular stagnation” (PDF).
It’s clearly not a good thing that the U.S. economy is maxing out at a relatively low level of output. But if the secret to happiness is lowering your expectations, as some people say, maybe we should all be happy now.