Weekly Economic Commentary by Scott J. Brown, Ph.D.
The Budget Deficit
May 13 – May 17, 2013
The Monthly Treasury Statement showed a large budget surplus for April. Some of that may prove to be temporary. Income was pulled forward into 2012 ahead of expected tax increases in 2013 and that was reflected in higher tax payments in April. Some of it is payback from the bailouts of a few years ago (for example, earnings from Fannie Mae and Freddie Mac). However, much of the improvement reflects a rebound from a severe recession. Tax revenues are recovering and recession-related expenses are trending lower. The near-term reduction in the deficit may limit efforts to address the long-term problem.
For the first seven months of the fiscal year, tax receipts were up 15.9% from the same period last year – individual tax receipts rose 20.0% y/y, corporate tax receipts rose 21.4% y/y, and payroll taxes rose 10.6% y/y.
Outlays are down 0.6% from the first seven months of FY12. Spending for the current fiscal year is likely to be below where it was projected to be back in the summer of 2008. Federal employment is now lower than it was when Obama took office.
The deficit should continue to improve as the economy recovers from the recession. However, short-term efforts to reduce the deficit (the payroll tax increase and sequester cuts) will restrain the pace of the recovery (GDP growth is expected to be about 1.5 percentage point lower this year). We may still see growth in the 2.0% to 2.5% range, but it would have been much stronger (3.5% to 4.0%) without the fiscal restraint.
The fiscal cliff deal at the start of the year limited the self-imposed fiscal contraction in 2013, but did not resolve the debt ceiling issue. Recall that the debt ceiling was breached on December 31, but Congress waved the limit through February 15, then later extended that deadline to May 19. A grand bargain on fiscal policy is unlikely, but there could be some legislative changes in a deal to raise the debt ceiling this week. Lawmakers are well aware that “governance by crisis” is unpopular with the American people. A government shutdown is very unlikely. Remember, the debt ceiling does not authorize spending (that comes from Congress through budget authorizations or Continuing Resolutions). It merely allows for the government to make good on obligations that it has already made.
By now, readers should be well aware of the problems with the Rogoff and Reinhart study that purported to show a 90% debt-to-GDP threshold (beyond which the economy slows). There is no such threshold!
The deficit has been falling and is likely nearing a level that would leave the debt-to-GDP ratio stable or declining. That’s presuming that the economic recovery continues at a moderate pace. If the pace of growth improves more substantially, as would happen as the level of GDP moves towards its potential and slack is taken up, the near-term budget outlook will improve even more dramatically. However, the problem with the deficit has not been the short-term outlook. Rather, the problem is the long-term strains from Medicare as the baby-boom generation retires. Congress continues to focus on unhelpful short-term fixes and is largely ignoring the long-term problem.
All’s Well That Ends Well
May 6 – May 10, 2013
The economic data reports were decidedly mixed last week. However, the April Employment Report exceeded expectations, which provided a good excuse for share prices to move higher. Bonds were whipsawed, encouraged by the view that the Fed was less likely to taper its asset purchases, but then hit hard by the better-than-expected payroll figures.
Nonfarm payrolls rose more than expected in April, while figures for February and March were revised higher. Results were mixed across sectors, suggesting that manufacturing has softened, but the consumer appears to be in relatively good shape. Temp-help employment rose, an encouraging sign, but average weekly hours fell, suggesting less of a need to increase hiring. Prior to seasonal adjustment, we added 932,000 payrolls in April. Unadjusted payrolls are trending about where they were in 2006. We still have a long way to go for a full recovery.
State and local tax receipts have improved. Job losses at the state and local levels of government appear to be bottoming. They may not increase much from here, but it’s good if they’ve stopped falling. Federal government payrolls are trending down, now down 3,000 since December 2008 (so much for the “massive” increase in government that we keep hearing about). Some of this reflects the contraction in the U.S. Postal Service, but there appear to be some sequester effects. Sequester cuts don’t happen all at once. In fact, some government agencies had trimmed payrolls in anticipation of the cutbacks. Other job cuts are likely to show up in the months ahead.
Consumer spending was stronger than expected in March, but that reflects an impact of colder weather, which boosted the consumption of household energy, and is unlikely to be repeated. Unit motor vehicle sales were up significantly year-over-year in April, but the seasonally adjusted pace appears to have slowed. That may reflect a lagged impact from the payroll tax hike. On the other hand, wealth gains in housing and equities are likely providing support to consumer spending at the upper end of the income scale.
The manufacturing data have been generally weak. Average weekly hours in manufacturing fell further in April and overtime hours declined. Factory orders fell. March trade figures continued to show a softening trend in imports and exports. The U.S. economy is not getting any help from the rest of the world.
The Federal Open Market Committee left monetary policy unchanged last week. The policy statement was a near photocopy of the previous one (from March 20). However, there were two notable changes. The first was that the Fed indicated more emphatically that tighter fiscal policy is restraining growth. The second was an added statement on the Large-Scale Asset Purchases (QE3). Much of the recent Fed debate has been about when to begin tapering the rate of asset purchases. Instead, the FOMC suggested that the pace could be increased as well as lowered, depending on what happens with inflation and the labor market. The PCE Price Index, the Fed’s chief inflation gauge, rose just 1.0% in the 12 months ending in March and lower gasoline prices should push the y/y increase below 1% in April. That’s against a Fed target rate of 2.0%. Deflation (a general decline in the price level) is still unlikely, but Fed officials fear it more than anything else. It’s a small chance of a big problem, one the Fed takes very seriously. The Fed is justified in keeping an increase in the rate of asset purchases on the table. However, the employment figures are consistent with a tapering in Fed asset purchases late this year.
In short, the economy remains firmly on the recovery path, although growth is likely to remain uneven over time and across sectors. We still have a difference in the economic outlooks between the stock market and the bond market, but this should clear up somewhat when the data roll in mid-May.
1Q13 GDP Growth and Beyond
April 29 – May 3, 2013
The initial estimate of real GDP growth for the first quarter was lower than expected. Details were mixed, and surprising relative to what was anticipated at the start of the quarter. Government remained a drag on overall GDP growth, which is a major difference between the current recovery and rebounds from previous recessions. The first quarter figures don’t tell us much about the pace of growth in the current quarter and beyond, but most economist have lowered their GDP forecasts for 2Q13.
First of all, it’s important to remember that the first quarter growth figure will be revised, and revised, and revised. It’s not unusual to see the growth figure revised more than a full percentage point higher or lower than the initial estimate. However, the underlying story isn’t expected to change much.
Consumer spending growth was much stronger than anticipated at the start of the quarter. The two percentage point rise in the payroll tax was expected to hit consumer spending hard and the increase in gasoline prices surely wasn’t going to help. However, it seems likely that many individuals were unaware that the payroll tax had gone up (just as most were unaware that the rate had been lowered over the last two years). Some households appeared to have reduced savings. The savings rate is a seriously flawed statistic, but it fell to 2.6% in 1Q13, from 4.7% in 4Q12 (although a large part of that reflects the pulling forward of income ahead of expected tax increases). Some of the first quarter strength in spending may reflect a rebound from the effects of Hurricane Sandy. More importantly, the March retail sales report suggested a significant weakening of momentum heading into 2Q13. Yet, some of that weakness may have been a function of the weather.
Business fixed investment was also a lot different than what was expected at the start of the quarter. Recall that fiscal cliff fears were supposed to freeze capital spending in late 2012, and capital spending was expected to jump once that uncertainty was resolved. Instead, business fixed investment rose at a 13.2% annual rate in 4Q12 and slowed to a 2.1% pace in the advance estimate for 1Q13. Corporate profits, a major driver of business fixed investment, have remained strong, which bodes well for the second quarter.
Inventory growth slowed sharply in 4Q12, subtracting 1.5 percentage points for GDP growth that quarter. Some rebound was anticipated in the first quarter. The rebuilding of inventories appears to be largely complete, but the end-of-quarter inventory figures can be significantly higher or lower than was assumed in the advance GDP estimates.
Exports added 0.4 percentage point to 1Q13 GDP growth, but that followed a subtraction of the same size in 4Q12. Imports, which have a negative sign in the GDP calculation, subtracted 0.9 percentage point from GDP in 1Q13, after subtracting 0.7 percentage point in 4Q12. Averaging the last two quarters, the trends in foreign trade are about flat. The soft global economy seems unlikely to add significant support for U.S. exports in the near term. However, imports should rise as the U.S. economy continues to improve (although increased energy production will likely limit that trend relative to historical experience). In short, don’t expect net exports to be a major factor from here.
Government subtracted 0.8 percentage point from 1Q13 GDP growth. Most of that was in defense. Government consumption and investment typically provides support in an economic recovery. However, the decline over the last several quarters marks a clear departure from the norm. GDP growth averaged a 2.0% annual rate over the last ten quarters, but would have risen at 2.6% if not for the government contraction.
While most economists had raised their expectations for 1Q13 GDP growth heading into the advance report, they had also reduced expectations of growth for 2Q13. That appears to have been reflected in the bond market, but not the stock market. Data arriving over the next few weeks will be critical.
Comprehensive benchmark revisions to the GDP data are coming. On July 31, the Bureau of Economic Analysis will revise GDP figures back to 1929. The biggest change will be that spending on research and development by business, government, and nonprofit institutions serving households will be counted as fixed investment. In addition, expenditures on entertainment, literary, and other artistic originals will be counted as fixed investment. The level of GDP, currently a bit above $16 trillion, is expected to be raised by about 3%. This doesn’t mean that the economy is “stronger than we thought.” The level of economic activity and the pace of growth were whatever they were. What’s changing is how we measure that.
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