For a couple of years following the Great Recession, you would frequently hear policy experts, from the Federal Reserve Board’s Federal Open Market Committee to the private sector, bemoaning the continued “fiscal headwinds” that were holding back economic growth.
The issue was government spending – or, to be precise, the lack of it. In 2011 and 2012, spending at all levels of government was drastically reduced.
It’s easy to attack spending by the government as wasteful or unnecessary, but in reality, the dollars that federal and state agencies pour into the U.S. economy create a lot of jobs and get recycled back into the economy in the form of wages paid to workers and then spent, in turn, on goods and services. When government spending gets cut and there is no corresponding increase in private sector investment to offset it, the economy suffers.
The Brookings Institution’s Hutchins Center on Fiscal and Monetary Policy has been tracking the impact of fiscal policy on economic growth and found that that for the first time since 2010, the headwinds have finally ceased. On Monday the Center published a paper showing this change, which is based on the Center’s Fiscal Impact Measure. Fiscal policy at the state and federal level isn’t doing a whole lot to benefit the economy right now, but at least it is no longer actively hindering it.
Because hinder, it did.
“State and local spending fell sharply in 2010, subtracting about half a percentage point from GDP growth, a significant force in an economy growing at a 2.25 percent annual rate,” write Parinitha Sastry and Louise Scheiner. “Spending continued to edge down through the end of 2012. Although spending finally started to pick up over the past year and a half, the pace has been lackluster, as is evident in both state and local government hiring and investment spending.”
“Taken together, our estimates suggest that fiscal policy at all levels of government lowered real GDP growth by almost 1 percentage point, on average, over 2011 to 2013,” they found.
Private sector experts have come to similar conclusions.
“After being such a massive drag on the economy in recent years, the public sector is now a big positive,” Paul Ashworth of Capital Economics noted.
The finding comes at a particularly interesting moment because the U.S. electorate, on Tuesday, appeared poised to elect a new Congress fully controlled by the Republican Party – many members of which, including current House Budget Committee Chairman Paul Ryan (R-WI), are strong advocates of reduced government spending.
“There’s no question that a flipping of the political dynamics raises austerity concerns regarding fiscal policy – the idea that we could shift back to a period where fiscal policy was a big negative on growth is certainly a germane concern,” said economist Jared Bernstein, a senior fellow at the Center on Budget and Policy Priorities.
“On the other hand,” Bernstein said, “there are many Republicans who pose as budget hawks, but are really chicken hawks. They are happy to cut taxes and raise defense spending without much concern about the budget deficit.”
In fact, a large surge in Defense spending in the third quarter of 2014 played a significant role in Brookings’ determination that the direction of the fiscal winds had shifted.
“Defense spending tends to be pretty domestic, and doesn’t leak out in imports that much,” Bernstein said.
He also pointed out that House Republicans want to currently extend a number of programs collectively known as “tax extenders” without offsetting budget cuts – something that would substantially increase the deficit.
So, just as voters might not know the final results of a tight election on Tuesday night, economists wondering about the direction the GDP will take in the next Congress may have to wait and see as well.
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