Go, Dean Baker. Go!

Thoma links to Dean Baker. Baker quotes Mankiw:

"Nations run trade deficits when their spending on consumption and investment, both private and public, exceeds the value of goods and services they produce. If you really want to reduce a trade deficit, the way to do it is to bring down spending relative to production, not to demonize trading partners around the world."

and responds:

Without saying it, Mankiw has slipped in the assumption that the economy is already operating at its potential level of output so that a smaller trade deficit cannot boost output.

He's right, Baker. Potential Output is a supply-side measure. It's an estimate of how much we can produce, not of how much we can consume. Mankiw assumes we cannot bring production up relative to spending -- i.e., we are operating at potential -- and so says "the way to do it is to bring down spending relative to production".

I think this is a really brilliant observation by Dean Baker.