4 May 2012 – Macro Insight
Macro Insight: The Government is a Drag
The US economy posted a slower growth rate in the first quarter of 2.2%, disappointing expectations of 2.5%. The culprit wasn’t households or businesses, both of which made positive contributions. It was the government. In fact, the economy would have beat expectations if the government drag hadn’t sliced off 0.6 percentage points.
The Bureau of Economic Analysis tracks the US economy in four major categories; three of them have been adding to growth since the end of the recession in 2009. Personal consumption is the largest category, now accounting for 70% of GDP; it has already surpassed pre-recession levels in inflation-adjusted dollars and contributed to growth in all eleven quarters of the new expansion. Private domestic investment has yet to fully recover but is well above the lows, adding to GDP in all but one quarter of the expansion. Net exports, the third category, was slower to turn but has been more supportive of growth over the last year.
In stark contrast to the rest of the economy, government expenditures continue to contract and have now subtracted from real US GDP growth for six straight quarters, the longest such stretch since Eisenhower. The government, in other words, is still in recession.
About half the government drag comes from reduced military outlays, which are down 7% from the peak in September 2010 and might continue to edge down as overseas commitments are further curtailed. State and local government spending accounts for the other half; this part of the drag is beginning to stabilize and was almost flat in the first quarter.
The government’s contribution to economic growth can come directly from its expenditures and investment or indirectly through stimulus and other fiscal and monetary policies. In past business cycles since 1960, the government itself was usually an early source of growth in a new expansion. On average, government spending directly added about half a percentage point to the growth rate through this point of an expansion, as opposed to an average quarter point reduction in this cycle.
The government’s indirect contribution has been far more robust, although the longer-term implications have yet to be seen. There has been record-setting deficit spending at the national level and the Fed continues to hold interest rates at historic lows, together boosting personal consumption and private investment. A new study from Fitch Ratings and Oxford Economics estimates that US fiscal and monetary policies added more than 4% to overall GDP over the past two years. Some of that impact could be reversed when all the stimulus ends, particularly the scheduled expiration of the Bush/Obama tax cuts at the end of 2012. And the Fed’s eventual return to tight monetary policy looms heavily on the distant horizon.
For now, the economy has been firing on three pistons: consumption, investment, and exports. Government, the fourth piston, has been seriously misfiring. The headline GDP numbers could therefore be understating the health of the US recovery. At this point, the private sector has plenty of steam, softer payrolls notwithstanding, and so the government itself doesn’t need to be an engine of growth. It might be enough if the government just weren’t such a drag.
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