![]() ![]() Thought of another way, overfilling the fiscal gap could substantially reduce economic multipliers. One possibility is that the excess funds are economically ineffective, adding to the debt without improving the economy. It is therefore important to understand what might happen if policymakers spend substantially more than what is necessary to close the output gap. While the economy can operate above its long-term potential for periods of time, it cannot do so indefinitely or sustainably. Though many economists and experts such as Federal Reserve Chairman Jerome Powell have argued it would be better to overshoot with fiscal and monetary support than undershoot, that does not mean an overshoot of any magnitude is desirable. If potential GDP were 1 percent larger than CBO's estimate, the output gap would total $1.3 trillion through 2023 and the America Rescue Plan would close 115 to 145 percent of the output gap. On the other hand, many have argued that CBO is underestimating full employment and potential GDP. A one percentage point increase in Gross Domestic Product (GDP) growth would reduce the output gap to less than $200 billion, in which case the American Rescue Plan would be large enough to close eight to ten times the output gap based on the Edelberg and Sheiner numbers. Many forecasts and experts suggest the economy will grow faster this year than CBO estimates. The output gap could differ from CBO's projections. ![]() 3 Multipliers from their October 2020 analysis suggest that if the output gap were large enough, the plan could produce closer to $1.9 trillion of additional output and thus close about 275 percent of the output gap. 2 This estimate appears to be reduced by the fact that the economy would be performing in excess of its capacity, leading to some additional savings and inflation. 1 With a 1.5x multiplier, it would close the output gap 4 times over.īased on a recent analysis of the plan from Wendy Edelberg and Louise Sheiner of the Brookings Institution, the American Rescue Plan would theoretically boost output by about $1.5 trillion starting in the second quarter of this year, closing about 225 percent of the output gap through 2023. With a multiplier of 0.5x, for example, the plan would close 135 percent of the output gap. The theoretical effect of the American Rescue Plan on the economy depends on the economic multiplier associated with the new programs, but in almost any circumstance it would substantially overshoot the output gap as estimated by CBO. What Would the American Rescue Plan Mean for the Output Gap? ![]() This overshoot could be beneficial, but could also pose risks to the economy and the fiscal outlook. Assuming CBO's estimates are correct, President Biden’s $1.9 trillion American Rescue Plan would likely be enough to close the output gap two to three times over. This gap will total roughly $300 billion in the last three quarters of 2021 and nearly $700 billion through 2023, the period over which most future relief would take place. The Congressional Budget Office (CBO) projected on Monday that the nation’s output gap – the difference between actual economic activity and potential output in a normal economy – would be $380 billion for the rest of 2021. ![]()
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