Maybe Reagan was onto something…

Paul Krugman makes some good points about “post-modern” recessions (i.e., the last three, starting in 1990, 2001, and 2007, and which have all been followed by agonizingly slow recoveries) and then ends by asking, “And what about Reagan? Reagan who?” in making the point that very fast recovery following the 1981 recession was largely driven by monetary policy decisions.

This is mostly right, but, let’s look at the behavior of government spending following the last four recessions (i.e., the 1981 recession as well as the three “post-moderns”). The graph below measures real government spending relative to the previous business cycle peak.

So, 16 quarters after the start of the 1981 recession government spending was up nearly 19 percent relative to the pre-recession peak, while 16 quarters after the Great Recession of 2007, it’s up less than 1 percent. Let’s do some quick math. If we mimicked government spending growth from the 1981 recovery, government spending today would be about 18 percent higher than it was in the last quarter before the recession began – adding about $440 billion (in $2005) to overall GDP. This would lead to a roughly 3 percent boost to GDP and more than 3 million extra jobs not including any multiplier effects. Put a run-of-the-mill 1.4 multiplier on this and you have well over 4 million extra jobs – or roughly 40 percent of the entire “jobs gap” caused by the Great Recession that would now be filled.

Yeah, this is one thing about the 1981 recovery I’d like to replicate.