And therein lies the problem.
It’s become a bit of cliché to say we have a dysfunctional government, so let me be specific. We live in a $17.9 trillion economy, with a federal government sector that will spend about $3.7 trillion this year. Is it feasible that we can adequately manage such magnitudes with a political system that can’t agree on spending priorities such that with the end of the fiscal year less than two weeks away, they’re still not sure whether they’ll pass yet another budget patch that gets us to the next deadline or shut down the government?
True, more than half of those government outlays are on automatic, going to health programs (24 percent), Social Security (24 percent), and interest on the debt (7 percent). And before anyone freaks out, the 21 percent of spending as a share of GDP is precisely the historical average since 1979.
The ironic part is that while many politicians and pundits chafe at the automatic parts, they’re the only ones that reliably work these days. The success stories are Social Security, Medicare, safety-net programs like nutritional and wage supports, and most recently, Obamacare, which has been remarkably successful in lowering the rate of Americans without health coverage. And as regards interest on the debt, credit spreads reveal that global investors consider U.S. government debt among the safest in the world.
Meanwhile, Congress’s inability to adequately fund highways and transit system means that problem will soon loom large again. And fear not, adrenalin-addicts: once the excitement of the government shutdown is behind us, we’ll turn right to the debt ceiling debate. As noted, thus far the madness of suggesting that we could default on our sovereign debt hasn’t infected markets, but in this election cycle, how confident are you that the bevy of Republican presidential candidates will handle this…um…maturely?
Meanwhile, the mindless spending caps—“sequestration”—are still in play and are, along with the conservatives’ drive to defund Planned Parenthood, one reason why Congress may not be able to resolve their difference before the fiscal year ends on Sept. 30. Members on both sides want to break through the caps, but they can’t get there without working together, and so far that’s not happening (recall that Sen. Patty Murray (D-Wash.) and Rep. Paul Ryan (R-Wis.), managed to negotiate some sequester relief in late 2013).
So, what does all of this have to do with the economy? Can’t the Fed just pick up the slack and do all the heavy lifting on its own?
Nope. It take monetary and fiscal policy to close the output gaps we face in GDP and reduce the slack remaining in the job market.
The figure at the top of this post, by Goldman Sachs researchers (GS), shows the impact of changes in fiscal policy on GDP growth. When the Great Recession was at its worst, stimulus helped partially offset the demand contraction, adding to GDP growth in 2009-10. But the pivot to austerity, circled in the graph, while not of European dimensions, was still severe, particularly in 2011 and 2013.
Toward the end of the figure, you see that “fiscal impulse” —the impact of changing fiscal policy on growth — has been neutral of late and is predicted to be either flat, slightly negative, or slightly positive if policymakers can pull off another Murray/Ryan, break-through-the-caps deal. Neutral is better than negative, and in fact, job growth accelerated once fiscal policy moved to at least “do-no-harm” mode.
Perhaps that’s all we can ask from this Congress. No unforced errors. Keep your hands off of the recovery.
But that’s a terribly low bar. Accommodative Fed policy and flush capital markets will keep the cost of borrowing low, but cheap credit must be met by stronger demand from consumers and investors or capital will sit on the sidelines.
Deep investment in public infrastructure, in clean energy, a robust highway and transit bill, implementing ideas like the Fix America’s Schools Today (FAST!) bill—such ideas would move that fiscal impulse line into positive territory while taking advantage of borrowing rates that remain low, courtesy of the Fed.
That’s the one-two punch of monetary and fiscal policy working together.
Instead, we face the specter of another series of punches at the economy from policymakers who seem to have almost completely forgotten how to work together for the greater good. It’s a testament to the resiliency of our economy that given the dysfunction, we’ve continued to post decent growth rates. In fact, the consensus is that markets will just shrug off another shutdown as par for the course these days.
Probably so, but how long can we run an $18 trillion economy with one key branch of government so badly broken? I’d love not to have to find out the answer to that question.