The Status Quo: Fiscal Contraction

Michael Stephens | October 27, 2011

Ryan Avent digs into the latest GDP numbers at Free Exchange and lays out a set of facts that ought to be drilled into the heads of the public and every opinion-maker:  fiscal policy, particularly when you factor in state and local governments, has basically been either null or contractionary for almost two years now.

Federal government spending contributed positively to growth, as an increase in defence spending offset cuts on the non-defence side of the ledger. That positive federal contribution, in turn, offset continued contraction at the state and local government level. All told, the government contribution to output was essentially nil. Government consumption has contributed positively to growth in just 2 of the last 8 quarters. Non-defence federal government spending has contributed positively to growth in just 1 of the last 5 quarters. Generally speaking, fiscal policy has not been stimulative in nearly two years and has been clearly contractionary for the past four quarters. That’s a remarkable situation to contemplate given the rock bottom rates on Treasuries.

Truly remarkable.  Multiplier Effect recently featured a couple of posts pointing to Levy scholars arguing that aggregate demand management and short-term stimulus are inadequate to the challenges we’re facing.  It’s important to emphasize, however, that this does not mean the near-term fiscal position is irrelevant.  The status quo, for some time now, has not been marked by fiscal stimulus of any kind.  This economy needs more demand and the federal government has more than enough fiscal room to provide it; the fact that we may need a lot more than merely short-term stimulus does not detract from this point.

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