Five Things to Remember

1. The stock market is not the same as the economy. When the stock market was rising, it didn’t mean the economy was good. When the stock market is falling, it doesn’t mean the economy is bad (see here)
2. Much of the growth of the federal deficit went to fund economic growth abroad, not in the U.S.  Yes, I know that the official data shows that real imports are smaller today than when the recession started. It’s not true.
3. The official data are wrong. Real import growth is stronger than the numbers show, productivity and real GDP growth are much weaker. (see here).
4. The last thing the U.S. needs is another stimulus to consumption. Consumption leaks right out the door as higher imports.
5. The U.S. should be a production economy, not a consumption economy.  It’s time to stop chasing low consumer prices and focus on investment in physical, human, and knowledge capital. That’s the only path to sustained prosperity.

The End of the Fiscal Stimulus?

Did the first quarter mark the end of the fiscal stimulus?  And will it be enough to work?

People are always trying to judge the fiscal stimulus by whether it creates jobs.  But that was never the real justification for spending all that money.  The theory was that the economy has multiple equilibria–a good equilibrium where everyone is optimistic about the future,  companies invest, and households spend, and a bad equilibrium where everyone is  locked into a mutually reinforcing gloom about the future.  Then a big enough fiscal stimulus can forcibly kick the economy from the bad equilibrium to the good equilibrium.

The key term here is ‘big enough’.  I think of the stimulus as a big booster rocket for the economy. If the rocket is strong enough, it can put a satellite (the economy)  into a stable orbit. Not enough boost,  jobs are created by spending money, but the economy falls back to earth again once the stimulus stops (wow, that was a mixed metaphor, but I’m good with it).  

By this measure, the stimulus can only be judged successful or not after it stops firing.  Or to put it another way, we want to see if the private sector  continues to grow once the government stimulus is removed.

As it looks like tht critical moment has arrived.   Based on the latest BEA data,  the stimulus ran out of fuel in the first quarter, and we’re about to find out whether it gave the economy enough oomph to get back into orbit. 

Take a look at these two charts. First, the government contribution to GDP growth was negative in the first quarter–roughly one-third of a percentage point. This reflects mainly contraction of state and local governments–layoffs and reductions in investment. Basically any new building projects on the state and local level  have been put into the cold freeze.  

But the GDP stats don’t tell the full story, because transfer payments (Social Security, Medicare, unemployment insurance) are not included in the ‘government’ category of GDP. Instead, they show up in personal income.  So I calculated the government contribution to real personal disposable income growth.  That includes the change in government benefit payments and government wages and salaries, minus the change in income taxes and payroll taxes.

Surprisingly–at least to me–the government was a net drag on real disposable income growth in the first quarter of 2010.  A small drag to be sure–roughly 0.2% of disposable income–but certainly not a boost. An increase in benefits was more than offset by an increase in taxes paid.

In other words, the fiscal stimulus pretty much petered out in the first quarter.

So the second and third quarters will be key. Will the private sector be able to use the boost from the stimulus to get back into some reasonable economic orbit? Or will it fall back to earth again in a big splat?

Right now I’m evenly balanced between the optimistic and pessimistic possibilities in the short-run.  I see good signs of life, especially in the communications sector. But I worry about Europe, about cutbacks on state and local level, about trade and borrowing from overseas.  But that’s a different post.

Conundrum revisited: Why are gov’t interest rates so low?

Back in 2005, Alan Greenspan complained of a ‘conundrum’: The fact that long-term interest rates were refusing to rise, despite a sharp increase in short-term rates.  At the time, there were all sorts of explanations given. In retrospect, this puzzling behavior of the financial market was a sign of deep problems.

Right now, we are facing the conundrum, part II.  The  news is  dominated by the massive gov’t budget deficits, which stretch as far as the eye can see.  But despite the incredibly large  borrowing needs, Washington is actually raising money at lower rates than it did in 1999 and 2000, when the federal government was running a surplus.  Here are the two relevant charts. First, the interest rate on 10-year Treasury bonds.

And here’s the change in the federal budget balance, as a 12-month sum.  We can see how small surpluses turned into stunning deficits.

These are the sort of charts which are frustrating to deficit hawks and professors who have to teach macroeconomics. There seems to be no easy and straightforward link between budget deficits and interest rates

So let’s go looking for other reasons. First, inflation is about at the same level as it was in 1999 (the consumer inflation rate in the year ended December 1999 was 2.7%, compared to 2.8% in the year ending December 2009).  Second,  net exports as a share of GDP are roughly about the same level as they were in 1999 and 2000, suggesting that the U.S. has about the same need to borrow from overseas.

Is it possible that the federal government is getting such a good rate because the rest of the economy is not borrowing?  Here’s a chart of borrowing by all nonfinancial sectors–consumers, nonfinancial business, state and local governments, and the fed. Measured as a share of GDP,  borrowing is still roughly where it was back in 1999 and 2000. (I’ve given both the quarterly and the smoothed charts).  

So what the heck is going on here? It could be that the U.S. government still counts as the only safe investment out there, even with the big budget deficits.  Possible, but that depends on highly myopic investors.  It could be that the demand for funds globally is low. Or it could be that the bond market is trying to tell us that long-term expectations for growth are low.

It’s a conundrum.