In recent posts about the Recovery Act, I emphasized the simple points that employment and GDP grew more quickly when the stimulus was on and less so when it was fading. A few folks asked for evidence of my assertion that the stimulus was, in fact, fading. I was again reminded of this point when on the “This Week” show yesterday economist Doug Holtz-Eakin incorrectly asserted that fiscal policy wasn’t particularly austere or contractionary right now.
Here are two pictures of fiscal headwinds blowing the wrong way. The first, from Moody’s Analytics, shows fiscal stimulus strongest in 2009. Remember, real GDP was falling at a nightmarish rate of 9% in 2008q4, but growing by about 4% a year later—a HUGE 13% swing in growth, and strong evidence of the positive impact of fiscal stimulus.
But by 2011, the impact of the various fiscal programs was about zero, and next year, absent the kind of stuff I expect to hear from the President this week, they go negative, pretty big time (from Moody’s):
“Under current policy—if no changes are made—federal fiscal policy will go from being a small drag on growth this year to subtracting 1.7 percentage points from real GDP growth. For context, at the peak of the fiscal stimulus in 2009, federal fiscal policy added 2.6 percentage points to real GDP growth (see Chart 5). With such fiscal restraint, for the economy to simply grow at its potential in 2012—estimated to be 2.7%—private sector GDP would need to grow by well over 4%. Given the currently very weak recovery, this seems unlikely.”
Researchers at Goldman Sachs have their own version of the above that shows similar effects from Federal measures, but they add an important wrinkle: contractionary state budgets. Since states must balance their budgets, the only ways they can offset budget shortfalls is to cut services or raise taxes, both of which can be a drag on growth.
The GS analysis suggests that such state actions offset much of the federal stimulus in 2010 but as the fed stuff fades this year, you’ve got both state and federal fiscal contraction creating a drag on growth. Clearly, lots of other stuff is going on in the economy, both here and abroad, but with these fiscal headwinds blowing the wrong way, no wonder everything’s slowed down.
GS expects the state and local drag to diminish next year which will help a bit, but the fading federal measures, including the payroll holiday, which they break out separately, go the other way.
These pictures provide the macroeconomic backdrop for the President’s jobs speech this week. They should loom large in policy makers’ minds when they consider the measures he proposes.
They should, and for some, they will. But yes, I know that many of those we need to be thinking about such things are as far away from this reality as they can be.