The Recovery From the 2008 Collapse That Could Have Been: The Impact of the Fiscal Cuts

GDP Recovery Path with Govt Growth at Historic Average, 2004Q4 to 2013Q2

A.  Introduction

Previous posts on this blog (including this older one from 2012) have discussed how the sluggish recovery from the 2008 economic collapse could have been avoided if one had allowed government spending to grow as it had during Reagan’s term.  This post will look in more detail at what the resulting path for GDP would have been if government spending had followed the path as it had under Reagan, or even had simply been allowed to grow at its normal historical rate.

The 2008 collapse was of course not caused by fiscal actions, but rather by the bursting of the housing bubble, and its consequent impact both in bankrupting a large share of an overly-leveraged financial system and in causing household consumption to fall as many homeowners struggled to repay mortgages that were now greater than the value of their homes.  Faced with the high unemployment resulting from this, an expansion of government spending would have supported the demand for output and hence for workers to produce that output.  And initially, fiscal spending did indeed grow.  This growth (along with aggressive action by the Fed) did succeed in turning around the steep slide of the economy that Obama faced as he took office.  But since 2009 government spending has been cut back, and as a result the recovery of GDP has been by far the slowest in any cyclical downturn of the last four decades.

This blog post will look at alternative scenarios of what the recovery path of GDP could have been, had government spending not been reduced.  Two primary alternatives will be examined.  In the first, government spending is allowed to grow from the point President Obama took office at a rate equal to its average rate of growth over the period 1981 to 2008.  In the second, government spending is allowed to grow from the onset of the recession (i.e. from the fourth quarter of 2007) at the same rate as it had during the Reagan years, following the downturn that began in the third quarter of 1981.

B.  Government Spending Growth at the Historic Average Rate

In the first scenario, real government spending on goods and services (as measured in the GDP accounts, and inclusive of state and local government as well as federal) is allowed to grow at a rate of 2.24% per year.  This is the average rate of growth for government spending over the 28 years from 1980 to 2008.  This was a modest growth rate, and spanned the presidencies of three Republicans (Reagan and the two Bushes) for 20 of the 28 years, and one Democrat (Clinton) for 8 of the 28 years.  The 2.24% growth rate was substantially below the growth rate of GDP of 3.04% over this same period (note this is for total GDP, not per capita).  As a result, real GDP grew by over 50% more over this period than government spending did.  But this modest pace of government spending growth was substantially more than the absolute fall in government spending during Obama’s term in office.

Note that this path for government spending is not some special rate faster than the historical average, as would normally be called for in a downturn when fiscal stimulus is needed because aggregate demand in the economy is less than what is needed for full employment.  Rather, it is just the historical average rate.  This should be seen as a neutral path, with government spending neither purposely stimulative, nor purposely contractionary.

This path for government spending is shown as the orange line in the following, where the path is superimposed on the graph presented in the earlier blog post of such paths of government spending in each of the downturns the US has faced since the 1970s:

Recessions - Govt Cons + Inv Expenditures Around Peak, 12Q before to 22Q after, with growth at avg historical rate

Maintaining government spending growth at the historical 2.24% rate would have led to government spending well below that seen during the Reagan years (in the recoveries from the July 1981 and January 1980 downturns), roughly where it was in the recoveries from the November 1973 and March 2001 downturns, and well above where it was in the recoveries from the July 1990 downturn (during the Clinton years) and of course the December 2007 downturn (under Obama).  Government spending in the current downturn (the brown curve in the graph) has fallen substantially during the period Obama has been in office.

The graph at the top of this post then shows what the GDP path would have been if government spending would have been allowed to grow at the historic average rate.  The impact will depend on the multiplier.  As was discussed in the earlier post on fiscal multipliers, the multiplier for the US in this period of high unemployment and short-term interest rates of close to zero will be relatively high.  But for the purposes here, we will run scenarios of multipliers of 1.5, of 2.0, and of 2.5.  This will span the range most economists would find reasonable for this period.

The results indicate that had one simply had government spending grow at its historic average rate, the economy would likely now be at or close to potential GDP, which is what GDP would be at full employment.  But because of the fall in government spending since 2009 rather than this increase, current actual GDP is over 6% below potential GDP, and unemployment is high.  (Potential GDP comes from the CBO estimates used in its May 2013 budget projections, but adjusted to reflect the methodological change made by the BEA in July 2013.  Due to these adjustments, including for the GDP deflators used, the potential GDP path is not as “smooth” as one would normally see.  But it will be close.)

Republicans have argued that we cannot, however, afford higher government spending, even if it would lead the economy back to full employment, as it would lead to an even higher public debt to GDP ratio.  But as was discussed in a recent post on this blog on the arithmetic of the debt to GDP ratio, it is not necessarily the case that higher government spending will lead to a higher ratio.  The Republican argument fails to recognize both that GDP will higher (due to the multiplier, and indeed a relatively high multiplier in the current conditions of high unemployment and close to zero short-term interest rates), and that a higher GDP will generate higher tax revenues due to that growth, which will off-set at least in part the impact on the deficit of the higher spending.

The resulting paths for the debt to GDP ratios by fiscal year, using a 30% marginal tax rate for the higher income, would be:

Public Debt to GDP with Govt Growth at Historic Average, FY2009 to FY2013

The impact of the higher government spending is to reduce the debt to GDP ratios over this period.  The higher government spending leads to a higher GDP, and this higher GDP along with the extra tax revenues generated at the higher output means the debt rises by proportionately less.  The ratios fall the most, as one would expect, the higher the multiplier.  If one is truly concerned about the burden of the debt, one should be supportive of fiscal spending in this environment to bring the economy quickly back to full employment.  The debt burden will then be less.

The debt to GDP ratios still rise over these years.  This serves to point out that the assertion made by the Republicans that the public debt to GDP ratio has risen so much during Obama’s term due to explosive spending under Obama is simply nonsense.  The debt to GDP ratios rose not due to higher government spending, but primarily due to the economic collapse and slow recovery, which has decimated tax revenues.  With higher government spending, the debt to GDP ratios would have been lower.

C.  Government Spending Growth at the Rate During the Reagan Years

The second set of scenarios examine what the path of GDP would have been had government spending been allowed to grow, following the onset of the downturn in December 2007, at the same pace as it had during the Reagan years following the onset of the July 1981 downturn.  The path followed is shown as the green line in the graph above on government spending around the business cycle peaks.

The resulting recovery in GDP during the current downturn would have been significantly faster:

GDP Recovery Path with Govt Growth at Reagan Rate, 2004Q2 to 2013Q2

If government spending had been allowed to grow under Obama as it had under Reagan, the economy likely would have reached full employment in 2011 (multipliers of 2.5 or 2.0), or at least by the summer of 2012 (multiplier of just 1.5).  That is, the economy would have been at full employment well before the election.

The deb to GDP ratios would also have been less than what they actually were:

Public Debt to GDP with Govt Growth at Reagan Rate, FY2008 to FY2013

Note that for these calculations I assumed that once the economy reached full employment   GDP (potential GDP), that government spending was then scaled back to what was then necessary to maintain full employment, and not over-shoot it.  Hence the curves for the 2.5 and 2.0 multipliers move parallel to each other (and are close to each other) once this ceiling has been reached.

D.  Conclusion

Fiscal spending was not the cause of the 2008 collapse.  Rather, the cause was the bursting of the housing bubble, and the resulting bankruptcy of a large share of the financial system, as well as the resulting reduction in household spending when many homeowners found that their homes were now worth less than their mortgages.

But following an initial increase in government spending, in particular as part of the fiscal stimulus package passed soon after Obama took office, government spending has been cut back.  The scenarios reviewed above indicate that had government spending merely been allowed to grow at its normal historical rate from when Obama took office (i.e. even without the special stimulus package), the US would by now be at or at least close to full employment.  And if government spending had grown as it had during the Reagan years, the economy would likely have reached full employment in 2011.

There is no need to introduce some special factor to explain why GDP is still so far below what it would be at full employment.  There is no need to assume that something such as “business uncertainty” due to Obama, or new and burdensome regulations, have for some reason led to this slow recovery in GDP.  Rather, the sluggish recovery of GDP and hence of employment can be explained fully by the policies that have kept government spending well below the historical norms.

Government Jobs Have Been Cut in This Recession: This Has Hurt, Not Helped, the Recovery

I.  Introduction

A Republican theme in this Presidential campaign, asserted repeatedly by Mitt Romney and other Republican leaders, is that a sharp expansion of government under Barack Obama is the cause of the weak job growth in the recovery from the 2008 collapse.  Romney laid out this theme most clearly in his policy address on economic issues last March (see here for a transcript).  I noted in this blog entry that the address was confused and full of factual errors, but it does represent what Romney said he believes.  More recently, in remarks in Iowa earlier this month, Romney said of Obama that, “he wants another stimulus, he wants to hire more government workers.  He says we need more fireman, more policeman, more teachers.  Did he not get the message of Wisconsin?  The American people did.  It’s time for us to cut back on government and help the American people.”

As I have noted in a number of entries in this blog, government has in fact been contracting rather than expanding during this economic recovery, and that indeed the resulting fiscal drag can account for the weakness of the recovery.  See, for example, the posts on fiscal drag during the recession (here and here); the reduction in total government employment (including state and local) during the period Obama has been in office (here and here), with federal government employment flat and non-defense federal employment falling (here); and on federal government spending that has in fact been close to flat during the Obama term, in contrast to the sharp increases under recent Republicans (here).

Given the importance and centrality of this issue in the weak recovery, it is important to get the facts right.  While the previous blogs have looked at the relationship of government spending in recent US economic downturns to the pace of recovery of GDP, they have not explicitly examined the assertion Romney and his Republican colleagues have now raised that higher government employment accounts for the slow recovery in jobs.

This can be done quickly, through a series of graphs.  The analysis here complements and extends the earlier blog post on fiscal drag as the principal cause of the weak recovery from the 2008 collapse, and the blog post on the path of employment during these downturns.

II.  The Data

First, total employment (both public and private) has fallen more in the current downturn than in any other in the US over the last four decades, and the recovery once it bottomed out has been relatively weak:

Recessions, index of total employment before and after peaks, US, 1970s until 2012

Total employment was falling at a rapid rate when Obama took office (and at that point, had fallen by more than had been the case in any other US downturn of the last four decades).  Actions taken by Obama at the start of his administration (as well as aggressive actions by the Fed) started right away to bend this curve, and within a year it had bottomed out.  Since then there has been positive and remarkably steady employment growth, but at too slow a pace given the depth to which employment had fallen to make up for the initial decline.  The path has been the weakest seen in any of the recoveries from the downturns the US has faced over the last four decades.

(Note:  The figure above, and the ones below on employment, go out for 18 quarters.  This carries the data to the second quarter for 2012 for the downturn that began in December 2007.  The employment figures are the averages for the periods, and the June 2012 figure, not yet published by the BLS, was estimated based on the April and May figures.)

The graph for total private employment is similar, although with a somewhat stronger fall initially, until it bottoms out following the measures early in Obama’s term, and then a somewhat stronger recovery.  Private employment is now above where it was when Obama took office, but it still has not made up for the sharp fall in the last year of the Bush administration:

Recessions, index of total private employment before and after peaks, US, 1970s until 2012

In contrast, total government employment (including state and local, as well as federal) has followed a different pattern.  In contrast to private employment, it did not fall initially (during the last year of the Bush administration).  But once Obama took office, it has fallen steadily except for the temporary blip seen in the 10th quarter after the onset of the downturn, due to the temporary hiring for the decennial census in the Spring of 2010:

Recessions, index of total government employment before and after peaks, US, 1970s until 2012

The fall in government employment was particularly sharp once Obama took office, as can be seen more clearly in a graph which re-bases the data to equal 100 in the fifth quarter following the business cycle peak:

Recessions, index of total government employment starting fifth quarter after peaks, US, 1970s until 2012

In no other downturn has the US had such a cut-back in government employment.  Yet Romney and his Republican colleagues are arguing for even greater cut-backs, including for firemen, policemen, and teachers, as Romney stated in the quotation copied above.

Looking closely at the two graphs above on government employment, one might note that while the reductions in government employment were greater under Obama and in the most recent downturn than in any other, the second smallest was in the recovery following the January 1980 downturn.  This period was initially under Carter (for four quarters) and then under Reagan.  Since I have noted before in this blog that had government grown under Obama at the pace seen under Reagan, the economy would now be at close to full employment, is there a contradiction here?

The answer is no.  First, one should note that the “recovery” from the January 1980 downturn merges into that from the July 1981 downturn (but leading by six quarters), as the economy went into a new recession a half year after Reagan took office.  Reagan did cut back on government employment initially, before allowing it to grow.  Hence the paths followed by the green (July 1981) lines in the graphs above are more directly related to Reagan’s policies than those indicated by the blue (January 1980) lines.

Second and more fundamentally, the importance of the government sector to the economy and its recovery is more related to overall government expenditures than to simply the number of government employees.  Romney and his Republican colleagues are simply missing this point when they focus their criticisms on the number of government workers.  Reagan expanded government spending, but the focus was on things like defense expenditures rather than the number of school teachers.  Defense expenditures are done under contract to private companies (much of it to a few giant companies such as Boeing and Lockheed).  Building modern jet fighters and naval ships can be very labor intensive, but these are employees of private contractors, and are not directly classified as government workers.

The paths can be seen in the following graphs, similar to ones presented in the earlier blog, but now with 17 quarters shown rather than 16 (as there is now one quarter of additional GDP data available):

US recessions 1970-2012, total government expenditures before and after business cycle peaks

US recessions 1970-2012, total government expenditures from fifth quarter after business cycle peaks

Growth in government spending during the Reagan periods (the blue and green paths) is the highest of all, especially when one starts five quarters from the cyclical peaks (when Obama took office).

III.  Conclusion

In summary, if there was any basis for the belief of Romney and his Republican colleagues that cut-backs in government employment and spending would lead to strong growth, then the economy would be booming right now.  Government employment and spending in the current downturn, especially once Obama took office in January 2009, have been below the paths followed in each of the other downturns the US has faced over the last four decades.

The recovery has been weak because there has been weak demand for the goods and services that business could produce.  There is no point in hiring a worker to make something if you cannot then sell it.  Government demand has been weak, as seen in the graphs above, due to strong Republican opposition.  Investment demand has been weak, despite record low interest rates and high cash balances on corporate balance sheets, since there is surplus production capacity.  There is little point in investing to build even more capacity when what you have is not being fully utilized.  Consumer demand has been weak, both because of weak incomes (the high unemployment and depressed wages for those who are employed) and because of the collapse of the housing bubble, which wrecked household wealth.  And global demand has been weak, due to crises in Europe (with its own mis-guided policies focussed on austerity) and elsewhere.

The cause of this weak recovery is not that government has grown rapidly, but rather that is hasn’t.

Recovering from the Recession: Fiscal Drag Can Explain the Slow Recovery

I.  Introduction

Economic recovery from the 2008 financial collapse and economic downturn has been slow, with unemployment still high in 2012.  Republican political officials, whether the presidential candidates or the Republican leaders in Congress, have charged that this has been due to an unprecedented explosion in government spending during the Obama administration, and that the way to a fast recovery would be to slash drastically that government spending.  Senator Mitch McConnell, the Republican Leader in the Senate, for example, has repeatedly harped on what he has called the “failed stimulus package” of Obama, and has successfully blocked any effort to extend any fiscal stimulus to address the continued weak state of the recovery.

They point to the recovery during the Reagan years from the downturn that began in July 1981.  This was the sharpest downturn the US had suffered until then since the Great Depression, and the Republicans point to the subsequent recovery as an example of how (they assert) cutting back on government spending will lead to a strong recovery.  Unemployment reached a peak of 10.8% in the Reagan downturn in late 1982, surpassing even the peak of 10.0% reached in the current downturn.  But the unemployment rate then fell to 7.2% by election day in November 1984, and Reagan was re-elected in a landslide.

Recovery from the 2008 downturn has indeed been slow.  But it is simply false to say that fiscal spending has exploded during the Obama years, while it was contained during the Reagan years.  In fact, it was the exact opposite.  Understanding begins with getting the facts right.  And once one does, one sees that fiscal drag can fully explain the slow recovery from the 2008 downturn, while the recovery during the Reagan years was helped by the largest expansion of fiscal spending in any downturn of at least the last four decades.

II.  The Path of Real GDP

Start with the path of real GDP at each of the downturns since the 1970s (with the data here and below from the Bureau of Economic Analysis of the US Department of Commerce):

The graph shows the path of real GDP in the three years (12 quarters) before each business cycle peak since the 1970s (as dated by the NBER, the recognized entity that does this for the US), to four years (16 quarters) after the peak.  Recessions start from the business cycle peaks, with negative growth then for varying periods (of between 6 months and 18 months in the recessions tracked here) before the economy starts to grow again.  Six recessions have been called by the NBER in the US over the last four decades.  The NBER stresses that it concludes whether or not the economy went into recession based on a wide range of indicators, and not simply real GDP decline, but generally, negative GDP growth of two quarters or more is commonly associated with a recession.

As the graph shows, the downturn that followed the business cycle peak of December 2007 was the largest of any of those tracked here, with most of the decline occurring in 2008, before Obama took office, and in the first quarter of 2009, when Obama was inaugurated.  The economy stabilized quickly under Obama, and then recovered but only slowly.  By 16 quarters after the quarter of the business cycle peak (i.e. by the fourth quarter of 2011, the most recent period for which we have data), real GDP was barely above where it had been at the peak.  This was the worst performance for GDP of any downturn of those tracked here, and indeed the worst since the Great Depression (other than the fall in output after 1945, which is a special case).

The recession that began in July 1981 (shown in green in the figure) at first followed a strongly negative path, but after five quarters began to recover.  The economy then recovered faster than in any other US downturn of the last four decades, and by 16 quarters out, real GDP was over 14% above where it had been at the pre-recession peak. Republican officials argue that government cut-backs under Reagan account for this strong recovery.

III.  The Path of Government Spending

But what was in fact the path of government spending?  There are a couple of different measures of government expenditures one can use, but they tell similar stories.  First, one can look at direct government expenditures, for either consumption or investment.  This is the concept of government spending which enters directly as one component of demand in the GDP accounts:

In the downturn following the December 2007 peak, government expenditures rose in the first six quarters following the business cycle peak in the middle of the range seen in the other downturns.  But then it flattened out, and then it fell.  By the 16th quarter following the peak, real government spending was barely (less than 1%) above where it had been at the business cycle peak, four years before, and was the lowest for any of the six downturns of the last four decades (although close to that following the 1990 downturn, which was then into the Clinton years).  In contrast, government spending in the 1980s, during the Reagan years, continued to grow rapidly, so that by 16 quarters out it was almost 19% above where it had been four years earlier.  This growth in government spending during the Reagan period was by far the most rapid growth in such spending seen in any of the downturns.  Government spending growth following the March 2001 business cycle peak (i.e. during the Bush II years) was second highest after Reagan, but only a bit over 10% higher rather than 19% higher.

If one believes in the Republican assertions that fiscal spending will restrain growth and that fiscal cuts in periods of high unemployment will spur growth, then one would have seen slow growth during the Reagan period and rapid growth during the Obama period.  In fact, one saw the opposite.  Fiscal austerity is bad for growth, while fiscal expansion when the economy is in recession will spur growth.

It should be noted that government spending considered here is total government spending, at the state and local level as well as federal.  State and local spending is on the order of 60% of the total in recent years.  The cut-backs in recent years in total government spending has been driven by cut-backs in spending at the state and local levels, many of whom have followed conservative fiscal policy either by statute (balanced budget requirements when revenues are falling) or by choice.  In the four years following the December 2007 cyclical peak, state and local spending indeed fell by 6%.  This was offset to a degree by growth of 13% in spending at the federal level (of which 8.8% occurred in the last year of the Bush administration, while 4.1% total occurred over the three years of the Obama administration).  A similar breakdown during the Reagan years following the July 1981 downturn shows that state and local government spending rose by a total of 13.6% in the four years, while federal spending under Reagan rose by a total of 25.4% in those four years, for overall growth in government spending of 19%.  This large increase in federal spending does not support the common assertion that Reagan followed a policy of small government.  Federal spending grew almost twice as fast under Reagan as it did in the Bush II / Obama period following the 2008 downturn.

We therefore find that government spending on consumption and investment grew sharply during the Reagan years following the July 1981 downturn, more than in any other downturn in the US over the last four decades, and that the economy then recovered well.  In contrast, overall government spending (including state and local) was flat in the most recent downturn (rising at first in the last year of the Bush administration, but then flattening out and then falling), and the recovery has been weak.

It could be argued, however, that the government accounts that appear as a component of GDP (as direct consumption or investment of goods or services) do not capture the full influence of government spending on the economy, as it leaves out transfers.  Transfers include amounts distributed under Social Security, Medicare, unemployment insurance, and similar programs, which are indeed a significant component of government expenditures.  The purchases of good or services (or the amounts saved) are then undertaken by households, where it will appear in the GDP accounts.  But including transfers in the total for government spending will not change the story:

One again sees government spending increasing over the initial periods in each of the six downturns tracked, including that following the December 2007 peak.  This continues into the first complete quarter during the Obama administration, after which it flattens out and then falls.  By quarter 16, government spending including transfers in the Obama period is tied for the smallest growth seen in any of the six downturns (all at about 9% higher), along with that following the 1990 and 2001 downturns.  Once again, sharply higher growth is seen following the 1981 downturn, with total government spending including transfers was 21% higher after four years in this Reagan period.

By either measure of government spending, therefore, with or without transfers, government spending rose rapidly during the Reagan period while it flattened out and then fell during the Obama term.  This has produced a strong fiscal drag which has harmed the recovery.  In contrast, strong growth in government spending during the Reagan period was associated with strong GDP growth.

IV.  The Path of Residential Investment

There will, of course, be many other things operating on the economy at any given time, so it would be too simplistic to assign all blame or credit for GDP recovery on government spending alone.  Government spending is powerful, and does have a major impact on growth, but there are other things going on at the same time.  In the most recent downturn, the most significant other factor affecting aggregate demand for output has been residential investment.

Residential investment had risen sharply during the Bush II presidency, as has been discussed previously in this blog (see here).  The housing bubble then burst after reaching a peak in prices in early 2006 (see here), housing construction fell to levels not seen in decades, and such construction remains stagnant.

The collapse in residential investment seen in the most recent downturn in unprecedented.  While residential investment has typically fallen at the start of the downturn (and indeed was often already falling before the start of the overall economic downturn), the falls had never been so sharp and extended as now.  Four years since the business cycle peak in December 2007 (and six years since the peak in residential investment), residential investment remains weak, with no sign yet of recovery.  There are two reasons:  1)  The housing bubble reaching a peak in 2005/06 was unprecedented in size in the past half century, with residential investment reaching 6.3% of GDP in the fourth quarter of 2005, and then collapsing to just 2.2% of GDP in 2010/11; and 2) The downturn that started after the overall GDP peak in December 2007 was fundamentally caused by this bursting of the housing bubble, which led to mortgage delinquencies, financial stress in the financial institutions who held such mortgages, and then to collapse of the financial system.

V.  The Impact on GDP Recovery of the Fiscal Drag and of Housing

Finally, it is of interest to see what the impacts on GDP recovery might have been, had there not been the fiscal drag seen in recent years, or if residential investment had followed a different path.  There are many counterfactuals one could envision, but of particular interest would be the path of government spending seen during the Reagan years, as this is often held up by Republicans as the example to follow.  The following table shows what the impact would have been, along with a counterfactual scenario which keeps residential investment flat at the level it had been in 2007Q4.

Counterfactual Scenarios    All figures as a share of GDP.  Note that the shortfall from Full Employment GDP was 5.8% of 2011Q4 GDP (CBO estimate) Direct Impact Multiplier of 1.5
Government Consumption & Investment increases                                   as in 1981Q3-1985Q3 3.4% 5.1%
Total Government Spending (incl. Transfers) increases                             as in 1981Q3-1985Q3 4.0% 6.0%
Residential Investment flat at 2007Q4 level 1.4% 2.1%

The results indicate that the fiscal drag in recent years can by itself account for the shortfall of current GDP from its full employment level.  The estimate of full employment GDP comes from the January 31, 2012, economic baseline forecast of the Congressional Budget Office (see here), and is 5.8% above where current GDP was as of the end of 2011.  That is, if GDP were 5.8% higher, we would be at full employment (or “potential”) GDP, as estimated by the CBO.

In the first line of the table, government consumption and investment expenditure is increased by how much it was in 1981Q3 to 1985Q3 during the Reagan years, rather than the much slower growth (indeed essentially no growth) of 2007Q4 to 2011Q4.  The direct impact would have been to increase GDP by 3.4%.  Assuming a very modest multiplier of 1.5 (many would argue that the multiplier when the economy is in recession as now, with Federal Reserve Board interest rates close to zero, would be 2 or more), the impact would be 5.1% of GDP.  This is close to what would be needed to make up for the 5.8% gap.

In the scenario where total government spending (including transfers) is increased as it was during the Reagan years rather than the slow growth that has been chosen in recent years, GDP would have been 4.0% higher by the direct impact alone, and by 6.0% with a multiplier of 1.5.  This would have fully closed the gap.

One can also look at scenarios for residential investment.  Given how high the housing bubble had gone in 2005/6, it would be unrealistic to believe that housing would bounce back up quickly, and certainly not to the bubble levels.  But in a scenario where housing had simply recovered in real terms to the level seen in the fourth quarter of 2007 (when it was 4.0% of GDP), the direct impact on GDP would have 1.4%, or 2.1% assuming a multiplier of 1.5.  While still quite significant, these impacts are less than that resulting from the slow growth of government spending in recent years.

VI.  Conclusion

In summary:

1)  The recovery of GDP in the recent economic downturn has been slow, with unemployment still high.  Not only is a vast amount of potential output being lost, but long periods of unemployment is particularly cruel to the lives of those who must suffer this.

2)  Prominent Republican leaders have repeatedly asserted that the slow recovery has been due to an explosion of government spending under Obama.  This is simply not true.  Growth in government spending since the onset of the recession in December 2007 has been slower than in any other downturn of the last four decades in the US, and has been far less than the growth seen following the 1981 downturn during the Reagan years.

3)  Growth in government spending following the 1981 downturn during the Reagan period was in fact the highest by a substantial margin of any of the six downturns.

4)  If government spending had been allowed to grow in the recent downturn as it had during these Reagan years, the economy by the end of 2011 would likely have been at or close to full employment.

5)  Residential investment has also collapsed following the housing bubble that reached its peak in 2005/6, and has contributed substantially to the current downturn.  Its impact, while significant, is however quantitatively less than the impact of slow government spending, since residential investment is normally (and even at its peak) well less than government spending as a share of GDP.