I first wrote about the Muddle-Through Economy in 2002, and the term has more or less become a theme I've returned to from time to time.

In 2007 I wrote that we would indeed get back to a Muddle-Through Economy after the end of the coming recession. If you Google the term, at least in the case of the first four pages, more than half the references are to this e-letter. I get a lot of flak from both bulls and bears about being either too optimistic or too pessimistic. Being in the muddle-through middle is comfortable to me.

Last week I expressed my concern that we as a country are taking actions that could indeed “kill the goose” of our free-market economy (see: The Killing of America's Free-Market Economy). I rightly got letters asking me how I could maintain Muddle Through in the face of that letter. I’ve given it a lot of thought and research. How likely are we to muddle through in the face of $1.5 trillion and larger deficits? Today we take another look at Muddle Through. It should be interesting.

Muddle Through, R.I.P.?

I defined a Muddle-Through Economy in the past as one of slow growth (in the area of 1-2%) and a slack employment environment, such as we had in 2002 and the early part of 2003. In early 2007, I suggested we’d return at some point to such an environment at the end of the recession I was predicting.

I’m not surprised about the response of the Fed to the current recession and credit crisis -- whether it’s the large monetization of debt or the low interest rates. Assuming they more or less remove the monetary easing in a reasonable manner, there’s nothing that would make me think we don’t eventually recover, albeit at a very slow Muddle-Through pace, with a jobless recovery that lasts for several years. It won’t be pleasant, but we’ll survive.



However, never in my wildest dreams did I think we could be looking at government deficits of $1.5 trillion dollars and actually budgeting future deficits of over $1 trillion as far as the eye can see. And there’s real reason to think that under current plans, $1 trillion deficits are optimistic. Look at the graph above from the Heritage Foundation. They suggest that current policy would bring us closer to a $2 trillion deficit by 2019.

And that assumes nominal growth that’s north of 3% and unemployment dropping back below 5% in reasonably short order. If you make less optimistic assumptions, the number can become much larger rather quickly. Where do we find that much money to finance that large a deficit? We’ll look at what might be the answer, but first we need to look at a basic concept in economics.