And Policymakers Are Proposing to Withdraw Stimulus?

Three pictures and three quotes:

GDP growth is slackening:

Figure 1: Real GDP from 2011Q1 2nd release (blue bars), monthly GDP from Macroeconomic Advisers (red line) and from e-forecasting, all in billions of Ch.2005$. NBER defined recession dates shaded gray. Source: BEA, 2011Q1 2nd release, Macroeconomic Advisers (6/13), e-forecasting (6/21).

The output gap remains large, and will still be -3.6% in 2012Q4, according to the mean WSJ June survey.

Figure 2: Real GDP from 2011Q1 2nd release (blue), mean forecast from June WSJ survey (red) and potential GDP, all in billions of Ch.2005$. NBER defined recession dates shaded gray. Vertical line at 2009Q1. Source: BEA, 2011Q1 2nd release, CBO, Budget and Economic Outlook (January 2011), NBER, and author’s calculations. 


Finally, on the spending side, government expenditures on goods and services are a negative component of overall GDP growth, in an accounting sense.

Figure 3: Real GDP growth 2011Q1 2nd release (blue bars), contributions from state and local government spending (red bar), and Federal spending (green bar), all in billions of Ch.2005$, SAAR. NBER defined recession dates shaded gray. Vertical line at 2009Q1. Source: BEA, 2011Q1 2nd release, NBER, and author’s calculations. 


This figure reminds us that the Federal stimulus was largely offsetting contraction from the state and local governments. This point was highlighted in Aizenman and Pasricha‘s analysis of spending (on both goods and transfers).So, I think I understand where PIMCO’s Bill Gross is coming from (The Hill):

Bill Gross, the head of PIMCO, the world’s largest bond investor, on Tuesday lambasted politicians who claim deficit reduction will lead to job growth and called for new stimulus spending.

Gross is often cited by House Budget Committee Chairman Paul Ryan (R-Wis.) as having said the U.S. had only a few years to rein in the deficit to avoid a debt crisis. Gross sparked a lot of attention by dumping his holdings of U.S. Treasuries this spring.

“Deficits are important, but their immediate reduction can wait for a stronger economy and lower unemployment. Jobs are today’s and tomorrow’s immediate problem,” Gross wrote in PIMCO’s July Investment Outlook.

“Conservative or even liberal agendas that cede responsibility for job creation to the private sector over the next few years are simply dazed or perhaps crazed,” he said.

And from Fed Chair Ben Bernanke’s press conference yesterday (h/t Ezra Klein):

I have advocated that the negotiations about the budget focus on the longer term, say 10 years, which is the budget window, or even longer if you’re taking into blth entitlement reform, for example. By taking a long run aspect we can help the economy by reducing interest rates that may rise suddenly, we may help increase confidence in the households and businesses so ink it’s desirable that we take strong action to lower our budget deficits over the longer term. In doing that I think it would be best not to, in light of the weakness of the recovery, it would be best not to have sudden and sharp fiscal consolidation in the near term.

That doesn’t do so much for the long-run budget situation, it’s a negative for growth … . I hope that the congressional negotiators will take a longer-term view.

I don’t think that sharp, immediate cuts in the deficit would create more jobs. I think in the short run that we’re seeing already a certain amount of fiscal drag coming from state and local governments from the withdrawal of previous federal stimulus, so I think in the short run, you know, the fiscal tightening is at best neutral and probably somewhat negative for job creation.

I think what people will understand, should understand is that our budgetary problems are long-run in nature, the projections made by the CBO, for example, talk about where our debt to GDP ratio will be in 2020, 2025 and so on. That doesn’t mean we should wait to act, the sooner we can act the better.

The most efficient and effective way to address our fiscal problems

longer run perspective not to focus the cuts heavily on the near term but by taking a perspective and making a credible plan for reducing future deficits will lower interest rates or prevent them from rising and we will increase confidence and that could be constructive.

If it’s entirely focused on the near term I don’t think that’s the optimal way to proceed.

Finally, I know there is a group of people who believe in fiscal contractionary expansions, despite recent econometric work highlighting the quite specific instances in which such episodes occur [1] [2] [3] (that’s why a little econometrics is a dangerous thing). In fact, JEC had a recent hearing, entitled “Spend Less, Owe Less, Grow the Economy”. Here’s the concluding paragraph from Chad Stone’s assessment of the expansionary fiscal contraction thesis:

The United States faces a serious long-term deficit problem and an immediate short-term problem of slow growth and high unemployment. Current economic and budget conditions in the United States do not look at all like the conditions in countries that have experienced successful deficit reduction through short, sharp fiscal contractions. Non-partisan experts like Fed Chairman Bernanke and the Congressional Budget Office warn against cutting deficits too fast. And as the non-partisan Congressional Research Service concludes from its analysis of the international evidence, cutting budget deficits too rapidly under current U.S. economic conditions is most likely to hurt the economy and ultimately be unsuccessful. If we go down this path, I’m afraid the lesson will be “Spend Less, Grow Less, Slow the Economy.”

By the way, here is the nonpartisan Congressional Research Service’s assessment of contractionary fiscal expansions. (If only our Congressional members read these reports…)

This post originally appeared at Econbrowser and is reproduced here with permission.