Robert Samuelson looks to fear and uncertainty as the reasons that the economy is not doing better. He would be better off looking to national income accounting.

The basic story is that we have a big gap in demand that can only be filled in the short-term by government spending. The reason is simple. The housing bubble was driving around $1.2 trillion in demand that disappeared with the collapse of the bubble.

Roughly half of the falloff in demand was in residential construction. We had a huge building boom in the bubble years which went bust when builders realized that we had an enormous oversupply of housing.

Around $500 billion is from lower consumption. In the bubble years homeowners were spending based on the wealth in their home. That wealth has now disappeared. Therefore they have cut back spending. Why should we be surprised?

We also lost another $150 billion a year or so in demand when the bubble in the non-residential real estate collapsed. Also cutbacks in state and local spending as a result of a loss of tax revenue also contributed to the drop in demand.

So why is Samuelson looking for an explanation for inadequate demand to restore full employment? Where exactly would he expect this demand to come from?

Measured as a share of GDP, equipment and software spending is already back to its pre-recession level. This is actually quite impressive given the large amounts of excess capacity in many sectors of the economy. While consumption is down from its bubble peaks, the saving rate is still well below the post-war average, suggesting that consumers are spending a surprisingly high amount. 

So where would Samuelson expect to see additional demand come from? In the longer term the gap in demand will presumably be filled by a reduction in the trade deficit spurred by a decline in the value of the dollar. Or at least that is what would happen if our system of exchange rates was working as it is supposed to. We will also see an increase in demand from construction as the oversupply of housing begins to be absorbed.

But in the short-run there is no alternative to having the government sector fill the demand gap. This is something that arithmetic fans everywhere recognize.

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