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The 10% gap

This chart compares the actual path of real GDP to a trend line that equates to 3.1% annual growth. About two-thirds of the trend growth rate is due to increased productivity, while one-third is due to growth in the number of people working. Recessions typically cause GDP to fall below its trend growth rate, and recoveries typically result in faster-than-trend growth. This behavior of GDP was described by Milton Friedman and I've discussed it before.

Actual GDP is now about 10% below where it could be if the underlying trends in productivity and population growth remain unchanged. The shortfall is now equal to about $1.5 trillion of lost income per year, and that is the true cost of this very weak recovery that we are experiencing. It's also a good measure of the degree to which unemployment and underemployment impinge on the lives of many millions of our citizens.

For all the terrible cost this latest recession and meager recovery have exacted, there is a bright side: the amount of un- and under-utilized resources in the economy is huge, and just waiting to be tapped. If Washington can steer a better fiscal and monetary policy course (e.g., shrinking the size and burden of government, lowering and flattening tax rates, broadening the tax base, and tightening monetary policy) then there is a staggering amount of growth that could be unleashed in coming years. In short, if government can get out of the way of the private sector, the future could be quite rosy.

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