Economic Recovery, Not the Deficit, is the #1 Problem

The preeminent domestic challenge that the United States faces is returning the nation as rapidly as feasible to full employment. The State of the Union should focus on how best to do that. This is today’s problem. The waste of potential output, currently running at roughly $1 trillion a year, is bad enough. The erosion of human capital of the millions of long-term unemployed and the blighted careers of the millions of young labor force entrants are even worse, injuries from which the nation will suffer for decades in lost potential output even after full employment is restored.

The problem that has mesmerized the nation of late, the long-term structural deficit, will eventually cause problems if left unattended. But it is not the most urgent problem the nation faces today. The optimal policy response both to the catastrophe of lost output and lost human resources and to the long-term structural deficit would be increased fiscal stimulus today combined with a combination of spending cuts and higher taxes set to take effect after the nation has returned to full employment. Unfortunately, fiscal policy today is acting as a drag on the economy, rather than helping the recovery. And things threaten to get much worse when, as now seems likely, the sequester takes effect.