According to the Congressional Budget Office (CBO) the U.S. has a cumulative output gap of $2.8 trillion so far since the recession began.  That’s trillion with a TR, as in a million millions.  This is the core problem in the U.S. today and for the next couple years.  The recession saw the economy shrink and we simply haven’t aren’t getting back to where we were, let alone to where we could be.

Two of the most basic concepts in economics are the idea of opportunity costs and the technique of the counter-factual.   Both play a part in this analysis.  First, opportunity cost is the idea of the real cost of something or some choice isn’t the money expended but rather what you could have done but didn’t/can’t because of your choice.  Analyzing opportunity costs involves using the other idea, the technique of the counterfactual.  A counterfactual is a hypothetical outcome that could have been or even would have been, but didn’t happen because of the choices made.  People use counterfactuals often, they just don’t call them such.  For example, if you imagine decide not to go to a party and you choose to stay home one night, you might imagine what would have happened if you had indeed gone to the party.  That’s a counterfactual.  It could be good and attractive (you would have had fun at the party and met someone very interesting) or it good be negative (you would have gotten drunk, tried to drive home, and got arrested for DUI).  Comparing actual events to counterfactuals is integral to economic analysis.

In the case of macroeconomics, we often use a counterfactual called “potential GDP”.  Potential real GDP is the amount of real GDP that would have been produced IF we had made policy choices that produced full-employment.  In practice potential real GDP is often estimated by a combination of extending the long-run trend line of GDP from previous decades and of calculating output per worker and multiplying times the number of potential workers.  In this case, the additional workers include not only those presently recorded as “unemployed” but also those workers or part of the population that used to work but are no longer working or classified as unemployed.  It’s a fairly involved statistical undertaking, but fortunately we have the CBO to do the heavy lifting for us.  The numbers and graphs are accessible via the wonderful FRED database at the St.Louis Federal Reserve bank.  The data series is called GDPPOT.

The CBO released it’s latest long-run estimates for GDP.  Here’s a graph comparing potential real GDP to actual Real GDP. It shows actual numbers for 2008- first half of 2011.  From then on it’s the CBO’s best estimates of future actual real GDP given present government policies.

Yeah, that’s an ugly gap between those two lines.  That’s the opportunity cost of lost potential.  We could have been $2.8 trillion dollars better off over the last 3 years (cumulative, not annual). We could have had tens of millions more working. But we didn’t.  More disturbing is that we will continue to underperform for many years.  The CBO doesn’t project getting back to full-employment and our achieving our potential output until the end of 2015 – four years from now.

But now here’s the catch.  The CBO estimates and analysis don’t offer any rationale or reason why they suddenly forecast a recovery in 2015.  Basically they are saying that surely something will happen in 2015 to bring recovery, but they can’t point to any policies or dynamics that will cause such a recovery.

My own sense is that this will take a lot longer to recover given the government’s current focus on debt, deficits, and cutting spending.  It’s the wrong policy mix to achieve full employment given this kind of output gap.  We will eventually get back to full employment – if nothing else, sooner or later people die off and equipment rusts away.  But we’re in the middle of an ongoing depression and current policies won’t change that.  (note I said depression, not a “Great depression”)