I’d like to draw your attention to two dramatically different visions of the present condition of our economy and what policies we should be using to move forward (not to mention presentation approach). First, Menzie Chinn at Econbrowser presents a pretty conventional Keynesian argument (this is from the Policy Implications section):
Even if the economy continues to grow, the pace of GDP expansion is still far below that necessary to shrink the output gap quickly
As of 2011Q2, the cumulative output loss associated with the $2.8 trillion (in Ch.2005$). Using the August 2011 WSJ survey mean forecast, by 2012Q4, an incremental $1.4 trillion cumulative loss is incurred.
Given the deterioration in the economic outlook, I think it absolutely imperative that additional measures be implemented to sustain economic growth. Jim provided some monetary/fiscal options here.
My own suggestions, ignoring the political constraints imposed by those Republicans who have suddenly changed their views regarding optimal policies , include an employment tax credit , extension of the payroll tax reduction , resumption of transfers to the states (recall, if government employment had not declined, NFP employment would have increased in August), and of course substantial infrastructure investment (I argued for this back in the ARRA debates, but there were many Republican critics who argued that such spending would be ill timed, occurring long after the recession  … I expect those same critics to argue against infrastructure spending again, with yet different rationalizations ). Some other ideas .
Note, especially, the graph in that section. Dr. Chinn draws a straight line projection of GDP from its 2007 peak and labels it Potential GDP, draws another line of actual GDP, does a straight line projection of that from the most recent data, and labels it Actual. The difference between potential and actual is the output gap. The policy proposal is for government spending to fill in that gap.
My biggest problem with the model is that I’m skeptical of the potential GDP projection in the aftermath of a bubble. What is the unit of measure being used for GDP? Dollars. The dollar value of the bubble commodity should not be included in straight line projection from the 2007 peak. What should it be? Beats me.
An alternative view is presented by Arnold Kling in a greenboard presentation:
In his presentation he explains our current situation as the interaction among four forces or groups: Invaders, Helpless peasants, Fortified towns, and the government. Rather than using his terminology I’ll call them disruptors, rent-seekers, the powerless, and the government. Disruptors, those who’ve been able to exploit the new Internet and information-based technologies, have prospered. Rent-seekers, those who’ve been able to secure above market level wages via various forms of government intervention, have prospered, too. The powerless are in trouble. The government pretends to worry about the powerless, tries to manipulate the disruptors, and is really in the business of protecting the rent-seekers.
His explanation suffers from the problem typically encountered by libertarians: his proposal for what should be done is nowhere near as appealing as the proposals of the central planners.
There’s one point I’d like to add using a combination of Dr. Chinn’s and Dr. Kling’s terminologies. What I think has happened is that we expected the projected GDP from Dr. Chinn’s graph and have realized the actual GDP from his graph. Wage expectations on the part of the rent-seekers are predicated on that projected GDP. Government can’t deliver on those expectations.
It can’t extract the difference from the powerless. They just don’t have the resources. It can’t extract the difference from the rent-seekers. That’s the cat and rat farm&148; I’ve written about before. It’s perpetual motion. It violates the laws of physics.
If it extracts the difference from the disruptors is will be, in effect, eating the seed corn and reducing future economic activity. It’s not solution, just kicking the can down the road and we are rapidly running out of road. The only real solution is to deliver what you can to the rent-seekers, not what they expected or what was promised. Failing to do so will bring down the government, the rent-seekers, the powerless, and the disruptors all.