Will fiscal policy save the US economy or torpedo it?

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?


6 thoughts on “Will fiscal policy save the US economy or torpedo it?

  1. Great blog as usual, Shaun. You write: “The US Federal Reserve is increasingly expected to cut interest-rates and to undertake more QE style purchases of US government debt.” In Paul Volcker’s recent memoir, “Keeping At It” he makes clear what a different world it was when he started working at the New York Fed in 1952. Fed Chairman William McChesney Martin stood behind the “real bills doctrine” that:
    “[It was an abuse of the Fed’s power for it to buy or sell securities that weren’t directly related to conducting monetary policy (that is, anything longer term than three-month Treasury bills or overnight ‘repurchase agreements’)…
    “The term ‘bills only’ long ago fell out of common use, but its practical application remained in force for decades… Only the massive interventions in the securities markets during and after the 2008 financial crisis..confirmed its demise. Under the rubric of ‘quantitative easing,’ debt management seems to be back in a more exaggerated style.
    “Few tears have been shed. Bu what hasn’t disappeared is the basic underlying question: How far should a central bank…go in indirectly financing budgetary deficits and influencing the distribution of credit broadly in the economy?”

    • Hi Andrew and thank you.

      Firstly congratulations to the Toronto Raptors and their victory in the NBA finals.

      I think that the QE era would not be possible without the era of “independent” central banks. If politicians had remained in charge of central banks I do not think they would be able to enact a policy which helps them so much. So from their point of view giving central banks the appearance of reality and for a while maybe some in reality was a masterstroke. It reminds me of the episode in Yes Prime Minister where the apocryphal civil servant is asked if such a body could be influenced? He replies that would be very wrong. instead you appoint people who do not need influencing and that is the way the Bank of England for example has definitely gone.

  2. Hi Shaun

    It seems to me that we have a circular firing squad situation here.

    In a period of low interest rates it’s sensible to use discretionary fiscal policy as a complement to monetary policy.

    The fall in the ten year may mean the economy is edging to outright deflation.

    However, the yield curve has inverted and this is a classic signal for recession. During a recession the automatic stabilisers kick in and that, together with the discretionary spending sends the deficit up quite sharply.

    The combination of rapidly expanding debt levels with possible outright deflation will send the debt dynamics through the roof. In it’s turn this may impact on the dollar whose fall may have to be arrested by increases in rates which would cause further mayhem.

    I would expect QE4 and maybe QE Infinity, not that they’ll do any good but faute de mieux.

    When you’re in this position something fundamental is wrong and one does have to wonder whether the period of outright fiat currencies, in place since 1971, is coming to an end. The Democrats are apparently discovering the delights of MMT which is perhaps the surest sign yet that we’re at the end of days.

    • Hi Bob J

      I am not so sure about the deflation point or to be more specific I think that all the easing and QE are the biggest dangers. We are digging ourselves into a trap where interest-rates always end up lower than before. Even the Fed which to be fair was at least willing to raise rates only got to 2.5%, the ECB has not even tried since 2011 and after 6 years of rhetoric the Bank of England has managed in net terms a mere 0.25%.

      But as you say if you are going to use fiscal policy you may as well do so when it is cheap. I doubt anyone will be looking for an economic reset button any time soon as I suspect the establishment will hang onto fiat currencies until the bitter end.

  3. If fiscal policy isn’t the saviour, I think the Fed are going to go totally ape s**t and go negative rates together with QE(many multiples of its previous iterations) to keep these bubbles inflated, they have no other option.

    Powell and his colleagues have virtually said as much in recent statements, gold has responded in due course.

    Powell has committed the Fed to maintaining the stock market as his mechanism for stimulating demand, he is now about to find out what a demanding, screaming petulant baby he has created and how it will react when it doesn’t get what it wants.

    • Hi Kevin

      Your comment got me to take another look at the gold price and we have had a couple of runs up to these sort of levels since the last bull run. We need to break US $1400 for it to be a significant move I think or another signal might be Max Keiser coming back to prominence again.

      As you say the Powell Put Option is now in operation and after the meetings around New Year we seem to be in a new era for The Plunge Protection Team.

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