Don’t Be Embarrassed

February 13, 2009

This morning, Paul Krugman writes:

The Congressional Budget Office, not usually given to hyperbole, predicts that over the next three years there will be a $2.9 trillion gap between what the economy could produce and what it will actually produce.  And $800 billion, while it sounds like a lot of money, isn’t nearly enough to bridge that chasm.

I guess a high percentage of my posts start with a quote, because usually it is a quote that gets me in the mood to write a post.

I’m trying to make sense of this quote. I think it implies an analogy, that the United States’ economy is like a machine, when you turn it on it produces goods and services. The machine will be turned off for the next three years, but if it were turned on, it would produce $2.9 trillion in additional goods and services. It would be pretty stupid to have a machine and not use it (there’s a huge opportunity cost), so the stimulus is necessary to “turn the machine on,” as it were.

I’m stumped on coming up with a cutesy argument of my own to cast doubts on this model, so I’ll just have to skip to my point: why do we think that extrapolating out a 3% real growth rate of GDP is provides useful information for what we should do on economic policy?

Here’s an exercise: try to think in concrete terms about what the government can do to fill that $2.9 trillion gap in GDP. Specifically, what are those resources that are not being used, but which could be used, for $2.9 trillion in profit? How can we find them and use them?

When I try to perform this exercise, I just get confused. So the question is, who should we have faith in to get us out of the recession? What kind of stuff would you have to know to fill the $2.9 trillion gap well, and who knows it?

In Macroeconomics, I think people pretend to have knowledge that they don’t really have.

Hayek said this much better than I just did.

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