Austerity has been dragging on the economy. But maybe not for much longer.

July 3, 2013

Michael Feroli, the chief U.S. economist of JP Morgan Chase, has a new report out looking at just how much federal and state cutbacks have slowed growth in the last few years. Think of it as a good news/bad news story. The bad news: The drag has been a significant reason why the economic recovery has been so sluggish. The good news: It may finally be winding down.

Here's Feroli's estimate of how much "drag" or "thrust" federal fiscal policy has exerted on the economy in each of the last few years.

DeficitDecomposition

At the high water mark of the stimulus act, in 2010, the federal government boosted the economy to the tune of 0.4 percentage points. It has been a net negative ever since. The good news? The current, 2013 fiscal year (which ends in September) is set to be the year of the largest fiscal drag. So, starting next fiscal year, austerity will be less of a drag on the economy than it has been in either of the last two years (though that is, of course, subject to change if Congress sets a new policy course).

Meanwhile, state and local government budget-cutting has already lessened its drag on the economy, as shown by a second chart from Feroli that looks at employment by that sector. It may not be a boom time for state and local government jobs, but the sector did pass a key threshold in May, adding jobs on a year-over-year basis for the first time since 2009.

Source: JPMorgan/BLS
Source: JPMorgan/BLS

In other words, the drag from tighter fiscal policy seems to finally be easing -- which should mean stronger economic growth, if economic models like those used by Feroli and other mainstream forecasters are correct.

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