Eakinomics: Will The Recovery Die From Too Little Spending?

In recent weeks, a consistent theme from policy analysts on the left is that it is imperative to lock in additional spending – automatic extensions of unemployment insurance and the like – if the economy is to recover. The argument is that the federal “austerity” choked off the recovery after the financial crisis.

My first instinct is that this gives too little credit to the power of the private sector. After all, the arrival of the pandemic caused a record one-month decline in consumer sentiment, a record falloff in retail sales, and dragged an economy that had growth in January and February into negative territory for the 1^st quarter.  A rebound can be just as powerful in the other direction. If there is solid, pro-growth policy in place, output and employment can continue to grow.

Second, I’m not sold on the evidence. Let’s take a look at the table below. The first column shows the growth rate in real gross domestic product (GDP) in the 4^th quarter of each year (measured from the 4^th quarter of the previous year). The next three columns contain measures of fiscal policy.

Specifically, column two is the change in the budget deficit – the conventional Keynesian measure of fiscal stimulus. But it is not the conventional deficit; it is the portion of deficit driven by policy changes and not simply due to a falling or rising economy. This is the “cyclically-adjusted” change, compliments of the Congressional Budget Office (CBO). (Negative numbers are bigger deficits.) Columns three and four are the revenue and spending components of the deficit, respectively.

What story does the table tell? There are two periods of weakening GDP growth in 2011-12 and 2015-16. It is true that the deficit declined – Keynesian tightening – in 2010, 2012, and 2013. So, it’s not precise, but the slowdown is surrounded by fiscal tightening. Unfortunately, the same cannot be said of the 2015-16 slowdown, which occurred in an environment of fiscal expansion.

A bigger blow to the spend-or-die thesis is in columns three and four. Column three indicates steady tax increases, including massive rises in 2013 and 2014. In contrast, column four hardly indicates steady declines in spending; instead, the bulk of the perceived “austerity” stems from rising taxes.