Greg Ip has a fantastic blog post on the subject of America’s GDP growth and the potential thereof. He’s talking about this chart:
The blue line, here, is actual US GDP. The green line is what’s known as “Potential Gross Domestic Product” — the amount of output that the Congressional Budget Office reckons that the US could produce, if it were running at full capacity. (Don’t be confused by the weird formula: potential GDP is released in real 2005 dollars, so I’ve multiplied that data series by the GDP deflator to convert it to nominal dollars. You’ll see why in a minute.)
The main worry in this chart, of course, is the fact that the blue line — actual GDP — is so far below the green line, which is where by rights we should be. Up until the Great Recession, the two series tracked each other very closely. Now, however, they diverge by some $890 billion. That’s $7,800 per household, per year.
Greg’s point is that the green line might well overstated: that the economy can’t in fact grow, sustainably, at the kind of pace that the CBO is assuming it can. As he puts it: “both the level and growth rate of American potential output is much lower than we think”.
I think this theory is entirely plausible. And to demonstrate why, I’m going to take the exact same graph above, but add one more data series to it — this time the amount of credit outstanding in America.
There’s a whole narrative in this chart. From 1970 through the beginning of the crisis in 2008, GDP grew at a pretty steady pace. But the amount of debt required to generate that output just got bigger and bigger — the rate of growth of the credit market was much faster than the rate of growth of GDP. In 1970, GDP was $1 trillion while the credit market was $1.6 trillion: a ratio of 1.6 to 1. By 2000, when GDP reached $10 trillion, the credit market had grown to $28.1 trillion: a ratio of 2.8 to 1. And by mid-2008, when GDP was $14.4 trillion, the credit market was $53.6 trillion. That’s a ratio of 3.7 to 1.
In other words, in order to keep up a steady rate of GDP growth, we had to saddle ourselves with ever more cheap and dangerous debt.
Then, suddenly, the growth of the credit markets screeched to a halt, and we had a major recession. And since then, the size of the credit market has been roughly flat.
It makes sense that if we needed ever-increasing amounts of debt to keep up that long-term GDP growth rate, then when the growth of the debt market stops, our potential growth rate might fall significantly.
I’m glad that we’ve finally put an end to the credit bubble, which had to burst at some point. But it’s naive to think that we can do so without any adverse effects on broad economic activity. So we might indeed have to resign ourselves to lower potential growth going fowards. If only because we’re taking ourselves off the artificial stimulant of ever-accelerating credit.