Two Views of Fiscal Headwinds

September 5th, 2011 at 2:39 pm

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.


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4 comments in reply to "Two Views of Fiscal Headwinds"

  1. foosion says:

    The argument I hear most is that deficits in themselves are stimulative. The fact that we’re running large deficits and the economy is stuck is cited as proof stimulus doesn’t work.

    I say that deficits in themselves are not necessarily effective stimulus, it really depends on the composition of spending, etc. Less revenue due to less income and increased normal social safety net spending due to a bad economy isn’t enough. I’d appreciate any thoughts on this subject.

  2. general c. san desist says:

    …headwinds? That’s just air resistance as we plummet to earth. The speech upcoming will simply dampen the spirits of the faithful & encourage further the ankle nipping from the ill-bred.

    Now is not the time to be timid nor conciliatory. Barry needs to think out of the box. One more speech that calls for such band aid remedies like payroll taxes & unemployment benefits & other picayune measures are for extended Business Cycle downturns…not effective tools in this lesser depression.

    One more…we must be competitive, rah, rah, rah…& I’m done with this fool. He should resign as ineffective, Biden makes Hillary VP & go from there. Hopefully, that team would have the stomach for this stuff, since Barry is incapable of doing his job. The bumblers behind Barry have failed the nation, time to move on or get a new team.

    I would hold my nose & vote Democratic no matter what, but I also am revolted by roadkill. Where are the representatives we voted for, cowering behind the media’s inaction. I keep hearing about the last landslide election, that the people have spoken. Looking behind the numbers, 16% of the primary vote & 19% in the general election is hardly a rousing call to arms.

  3. Rima Regas says:

    Please keep educating us, and advocating on our behalf. Too few economists are as active as you and Paul Krugman are. Seeing the two of you appear together on This Week was great. I hope you’re invited again together so you can deconstruct the ridiculous arguments that the Not-Serious-At-All pseudo-economists on the right would like us to believe. Between your explanations and the cries from progressive pundits about our president’s abandonment of the most basic Keynesian approaches, maybe – just maybe, we can hope to not only reclaim the lower house, but an overwhelming majority. Anything less than that and any hope of reversing course completely on many fronts will be dashed.

  4. timnlisa1 says:

    I really like the visuals but I would like to see this lined up with a graph on the GDP growth by quarter. It’s good to show what the stimulus spending did to GDP, but show it against what the actual GDP was so we can see what the GDP would have been without the stimulus.