The Economist:
Humbler horizons: WHEN the American economy emerged from recession three years ago, forecasters fell into two broad camps. Optimists reckoned brisk growth would quickly return the economy to its long-term potential level of output, the maximum sustainable GDP that could be achieved with the capital and labour on hand. That would pull down unemployment and prop up inflation. Pessimists, however, predicted sluggish growth.... What has actually happened.... Unemployment and inflation have moved in the directions that optimists expected. Since peaking at 10% in late 2009, the jobless rate has now fallen by nearly two percentage points.... Yet economic growth has averaged 2.5%, a rate more typical of the economy at full employment rather than when recovering from a deep bust....
But there is another, more troubling possibility.... Unemployment has fallen because there are fewer people available to work. Inflation is stable because there is less idle capacity to restrain prices. This would be bad news all round. America would be permanently poorer than would otherwise have been the case....
Policymakers do not embrace this scenario. Ben Bernanke, the Fed chairman, said last year that the crisis and recession had not left “major scars” on the economy’s potential. Other countries’ experience suggests he may be wrong. A 2009 paper by the OECD, a think-tank, studied 30 developed countries and concluded that crises on average reduced the level of potential GDP by 1.5% to 2.4%. Severe crises—America’s easily qualifies—knocked it back by nearly 4%. The International Monetary Fund, studying a much broader sample of crises, found that seven years after the onset of a banking crisis, GDP was on average still 10% below where its pre-crisis path would have put it....
What accounts for this stifling effect? Both the OECD and the IMF argue that crises stunt the three main ingredients of growth: capital, labour and innovation.... Official forecasters are coming round to this way of thinking. The Congressional Budget Office has repeatedly revised down its estimates of America’s output potential since 2007 (see right-hand chart). It reckons the output gap this year will be 5% of GDP; it would have been 10% had potential remained on its 2007 trajectory.... Earlier this year, staff at the Federal Reserve also marked down their estimate of the country’s potential GDP... America’s potential growth rate averaged just 1.8% from 2008 to 2010, far below the 2.5% that Fed policymakers generally cite as the long-term trend....
The IMF notes that countries that responded to past crises with aggressive monetary and fiscal stimulus, structural reforms and rapid repair of their financial systems limited the loss of potential. American policymakers have tried to apply those lessons but not, apparently, hard enough.
