The problem, he says, is that the overall size of the plan reaches a scale that jeopardizes major future problems. The total money proposed, in particular, exceeds most estimates of the ‘production gap’. (More on this below.) This implies that a large portion of spending will only decrease in the economy, which will cause prices to rise, which could hamper the rest of Mr Biden’s agenda and venture into a new recession.
This is not a conventional argument between leaders and doves with doctrines, but something more subtle. In the past, Mr. Summers in particular has repeatedly called for greater budget deficits to help combat ‘secular stagnation’, leading large global economies to slow growth, and he has supported major pandemic aid packages.
However, Summers says that over time, every new spending package should pay off gradually and become more long-term investment.
“There’s nothing wrong with aiming for $ 1.9 billion, and I can support a much larger figure in total stimulus,” he wrote in a follow-up article. “But an essential part of the program must be aimed at promoting sustainable and inclusive economic growth for the rest of the decade and beyond, and not just to support revenue this year and next.”
What is the production gap?
Imagine a world in which the US economy is at its full potential. Just about anyone who wants to work can get a job. Each factory is at its full capacity. The output gap is simply how far the economy is from the ideal state.
A traditional approach to fiscal stimulus has been to estimate the size of the gap, apply some adjustments to take into account the way federal spending circulates through the economy, and use accounting to decide how large a stimulus action is. must be.
If the government pumps too much money into the economy, it theoretically tries to generate activities in addition to the potential production, which is impossible to sustain for long. Workers may put in overtime, and a factory may be able to operate extra hours for a while, but eventually the workers want a break and the machines need to be turned off for maintenance. If there is more money floating around in the economy than there are goods and services, the result will not be increased prosperity, but higher prices as people offer the goods they want to buy.