Further fiscal drag poses risks to the US economy

One of the reasons for the slow US recovery has been weaker than usual government spending. The weakness started with fiscal consolidation at the state and local level, driven by sharp declines in tax revenues. The negative impact on the economy is now more pronounced at the federal level. In previous recoveries government expenditures provided cushion to the economy, while in this recovery the net impact of government activity creates a drag. Of course the recent tax increases have not been helpful either.

Source: DB

The most direct impact is visible in the number of government jobs - the impact on the private sector that services the government is of course quite large as well. The chart below shows the decline in government payrolls over time (not seasonally adjusted).

Source: US Department of Labor

While government payrolls continue to fall, the decline has been slowing - mostly due to the stabilization in state and local employment. Federal jobs however are another story.

Given the fiscal drag resulting from an already weak (relatively) federal spending, the US economy is highly vulnerable to a negative outcome of the upcoming debt ceiling/budget fight. And while tightening federal spending is absolutely vital, a disruption at this juncture could prove to be costly.

BNY Mellon: - The upcoming showdown between Republicans and Democrats of Capitol Hill over both the 2014 federal budget and the national debt ceiling is shaping up to be a battle royal in Washington...”

In fact the "showdown" has already started. Some Republicans have threatened to shut down the federal government (by withholding funding) if the administration does not compromise on the Affordable Care Act. Yesterday the Obama administration fired back (see video below). While nobody thinks the situation will turn as ugly as it did in 2011, a major budget disruption (beyond the sequester) could create a serious setback for the US economy. And in this tepid recovery there is little else that could cushion this potential increase in "fiscal drag".

What's particularly concerning however is that after having developed a "tolerance" to repeated budget fights, the public seems to have completely lost interest in the topic.

Google Trends for phrase "federal budget" (US-based searches only)

Enjoy!

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