The shock of liberal victories that could shape the economy, explained

The problem, he says, is that the total size of the plan grows to a scale that risks serious problems in the future. In particular, the total amount proposed far exceeds most estimates of the “output gap”. (More on that below.) That implies that much of that spending will only slow the economy, causing prices to rise, potentially hampering the rest of Mr. Biden’s agenda and risking another recession.

This is not a conventional argument between doctrinal deficit hawks and doves, but something more subtle. In the past, Mr. Summers in particular has repeatedly called for larger budget deficits to help tackle “secular stagnation”, in which the world’s major economies are mired in slow growth, and he has supported large pandemic assistance programs.

But Summers says any new spending program should pay off gradually over time and focus more on long-term investments.

“There is nothing wrong with targeting $ 1.9 trillion, and I could support a much higher total stimulus figure,” he wrote in a follow-up article. “But a substantial part of the program should be devoted to promoting sustainable and inclusive economic growth for the rest of the decade and beyond, and not just supporting incomes this year and next.”

What is the production gap?

Imagine a world in which the US economy is operating at its full potential. Almost anyone who wants to work can find a job. Each factory is at full capacity. The output gap is simply the distance between the economy and this ideal state.

A traditional approach to fiscal stimulus has been to estimate the size of this gap, apply certain adjustments to account for the way federal spending flows through the economy, and use this arithmetic to decide how big a gap is. stimulus action.

In theory, if the government injects too much money into the economy, it tries to generate activity beyond potential output, which is impossible to sustain for long. Workers can work overtime and a factory can operate overtime for a period of time, but ultimately workers want a break and machines have to stop for maintenance. If there is more money flowing in the economy than there is supply of goods and services, the result will not be increased prosperity, but rather higher prices as people will bid on the things they want to buy.