Will fiscal policy save the US economy or torpedo it?

by Shaun Richards

One of the features of the credit crunch era has been the shift in some places about fiscal policy. For example the International Monetary Fund was rather keen on austerity in places like Greece but then had something of a road to Damascus. Although sadly Greece has been left behind as it ploughs ahead aiming for annual fiscal surpluses like it is in a 2012 time warp. Elsewhere there have been calls for a fiscal boost and we do not need to leave Europe to see them. However as I have pointed out before there is quite a distinct possibility that President Donald Trump has read his economics 101 textbooks and applied fiscal policy into an economic slow down. Of course life these days is rarely simple as his trade policy has helped create the slow down and is no doubt a factor in this from China earlier..

Industrial output grew 5.0 percent in May from a year earlier, data from the National Bureau of Statistics showed on Friday, missing analysts’ expectations of 5.5% and well below April’s 5.4%. It was the weakest reading since early 2002. ( Reuters).

Also there has been another signal of economic worries in the way that the German bond future has risen to another all-time high this morning. Putting that in yield terms holding a benchmark ten-year bond loses you 0.26% a year now. Germany may already be regretting issuing some 3 billion Euros worth at -0.24% on Wednesday although of course they cannot lose.

US Fiscal Policy

Let us take a look at this from the perspective of the South China Morning Post.

The US budget deficit widened to US$738.6 billion in the first eight months of the financial year, a US$206 billion increase from a year earlier, despite a revenue boost from President Donald Trump’s tariffs on imported merchandise.

So we can look at this as a fiscal boost on top of an existing deficit. The latter provides its own food for thought as the US economy has been growing sometimes strongly for some years now yet it still had a deficit. In terms of detail if we look at the US Treasury Statement we seem that expenditure has been very slightly over 3 trillion dollars whereas revenue has been 2.28 trillion. If we look at where the revenue comes from it is income taxes ( 1.16 trillion) and social security and retirement at 829 billion and in comparison corporation taxes at 113 billion seem rather thin to me.

The picture in terms of changes is as shown below.

So far in the financial year that began October 1, a revenue increase of 2.3 per cent has not kept pace with a 9.3 per cent rise in spending.

If we look at the May data we see that the broad trend was exacerbated by monthly expenditure being high at 440 billion dollars as opposed to revenue of 232 billion. Marketwatch has broken this down for us.

Most of the jump can be explained by June 1 occurring on a weekend, which forced some federal payments into May. Excluding those calendar adjustments, the deficit still would have increased by 8%, with spending up by 6% and revenue up by 4%.

In terms of a breakdown it is hard not to think of the oil tankers attacked in the Gulf of Oman yesterday as I note the defence numbers, and I have to confess the phrase “military industrial complex” comes to mind.

What will recur are growing payments for Medicare, Social Security and defense. Medicare spending surged 73% — mostly because of the timing shift, though it would have rose 18% otherwise. Social Security benefits rose by 11% and defense spending rose 23%.

So we have some spending going on here and its impact on the deficit is being added to by this from February 8th last year.

The final conference committee agreement of the Tax Cuts and Jobs Act (TCJA) would cost $1.46 trillion under conventional scoring and over $1 trillion on a dynamic basis over ten years,

Thus policy has been loosened at both ends and the forecast of the Congressional Budget Office that the deficit to GDP ratio would be 4.2% this year looks like it will have to be revised upwards..

National Debt

This was announced as being 22.03 trillion dollars as of the end of May, of which 16.2 trillion is held by the public. Most of the gap is held by the US Federal Reserve. Just for comparison total debt first passed 10 trillion dollars in the 2007/08 fiscal year so it has more than doubled in the credit crunch era.

Moving to this as a share of the economy the Congressional Budget Office puts something of a spin on it.

boosting debt held by the public to $28.5 trillion,
or 92 percent of GDP, by the end of the period—up
from 78 percent now.

The IMF report earlier this month was not quite so kind.

Nonetheless, this has come at the cost of a continued increase in the debt-to-GDP ratio (now at 78 percent of GDP for the federal government and 107 percent of GDP for the general government).

Where are the bond vigilantes?

They have gone missing in action. The financial markets version of economics 101 would have the US government being punished for its perceived financial profligacy by higher bond yields on its debt. Except as I type this the ten-year Treasury Note is yielding a mere 2.06% which is hardly punishing. Indeed it has fallen over the past year as it was around 2.9% a year ago and last November went over 3.2%.

So in our brave new world the situation is one of lower bond yields facing a fiscal expansion. There is an element of worries about the economic situation but the main player here I think is that these days we expect the central bank to step in should bond yields rise. So the US Federal Reserve is increasingly expected to cut interest-rates and to undertake more QE style purchases of US government debt. The water here is a little murky because back at the end of last year there seemed to be a battle between the Federal Reserve and the President over future policy which the latter won. So much for the independence of central banks!

The economy

Let me hand you over to the New York Federal Reserve.

The New York Fed Staff Nowcast stands at 1.0% for 2019:Q2 and 1.3% for 2019:Q3. News from this week’s data releases decreased the nowcast for 2019:Q2 by 0.5 percentage point and decreased the nowcast for 2019:Q3 by 0.7 percentage point.

That compares to 2.2% annualised  for a month ago and 3.1% for the first quarter of the year. So the trend is clear.


As we track through the ledger we see that the US has entered into a new period of fiscal expansionism. The credit entries are that it has been done so ahead of an economic slow down and at current bond yields is historically cheap to finance. The debits come when we look at the fact that the starting position was of ongoing deficits after a decade long period of economic expansion. These days we worry less about national debt levels and more about the cost of financing them, although as time passes and debts rise that is a slippery slope.

The real issue now is how the economy behaves as a sharp slow down would impact the numbers heavily. We have seen the nowcast from the New York Fed showing a slowing for the summer of 2019. For myself I worry also about the money supply data which as I pointed out on the 8th of May looks weak. So this could yet swing either way although this from February 8th last year is ongoing.

The deep question here is can we even get by these days without another shot of stimulus be it monetary,fiscal or both?