Friday, February 5, 2010

Fiscal Stimulus

In order to justify the fiscal stimulus packages of the federal government we must be able to find some relationship between the government expenditures and the performance in the economy. Currently, there seems to be very little statistical connection between the year-over-year rate of growth of the real economy and the rate of growth of government expenditures.
Here is a chart showing the relationship between the year-over-year rate of growth of the real nondefense expenditures of the federal government (the upper line) and the year-over-year rate of growth of real GDP (the lower line). The first quarter pictured in the chart is the fourth quarter of 2007, the quarter in which the Great Recession is said to have started. The pattern is not changed when total federal government expenditures are used.

The average rate of change for real nondefense government expenditures during this time period is 5.9%. As you can see from the chart, the actual figures seem to be above the average during the earlier part of the period and below the average toward the end.
Also, you can see that the year-over-year rate of growth in real GDP was at its highest level in the fourth quarter of 2007 (+2.5%) and declined progressively reaching its trough of a negative 3.8% in the second quarter of 2009. With the large jump in real GDP in the fourth quarter of 2009, the year-over-year rate of growth became positive again, showing a 0.1% gain.
Fiscal policy on the spending side did not seem to play much of a role in the trajectory of the economy during the recession up to the present time. If anything, the recovery seems to have begun without much contribution of federal spending.
The factors that contributed the most to the swing in real GDP growth are real Gross Private Domestic Investment and Real Exports.
The trough in the rate of decline of real investment expenditure occurred in the quarter that real GDP troughed and showed a remarkable improvement, especially in the fourth quarter of 2009. The particular sectors that were strongest in the third quarter and the fourth quarter were nonresidential purchases of equipment and software and residential construction. The construction of nonresidential structures continues to be in a hole.
The pickup in the purchases of equipment and software is a good indication that, at least, in some business areas, companies are acquiring products that will contribute to their more efficient performance as the economy picks up. In terms of the investment in residential construction the best explanation that can be given is that things have been down for so long that any construction seems to be an improvement.
Real exports also moved higher in the third and fourth quarters of the year and outpaced increases in real imports. This movement can be associated with the decline in the value of the United States dollar in the second half of 2009.
However, the major contributor to the increase in real GDP in the third and fourth quarters of 2009 was the rise in nonfarm private inventories. These inventories had declined constantly from the fourth quarter of 2007. There was a slight increase in nonfarm inventories in the third quarter, but the increase in the fourth quarter was substantial. Analysts are interpreting this rise in inventories as being a very positive sign for the economy because it indicates, to them, that some businesses are becoming optimistic enough about the possibility of rising future sales that they are building inventories to meet the potential increase in demand.
The good news is that there seems to be some life out there in the economy. The bad news is that the good news does not seem to result from the fiscal stimulus coming from the government even though the government is building up massive amounts of debt to support it spending programs.
Obviously, the large deficits are resulting more from a shortfall in revenues than from the increases that are taking place in spending. However, the government needs to be aware of what it can accomplish and what it is accomplishing. The perception of the people and the perception of the financial markets are crucial to the success or failure of a presidential administration. Right now, the spending programs appear to be contributing little toward improving economic activity.
Consequently, the perceptions about what the administration is achieving don’t seem to be that favorable for the Obama team. And, the new budget figures released this week didn’t seem to help that perception at all. (See Somehow, the president is going to have to turn this around or it is going to be a long three more years.

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