Beware the Huge Negative Lag Impact of Three Rounds of Covid Stimulus

Estimates from econometric studies indicate that the government expenditure multiplier is positive for the first four to six quarters after the initial deficit financing, then turns negative after three years. The lag now begins to bite.

The Hoisington Management 2023 Q2 Review by Lacy Hunt is another gem. His focus this quarter is on government debt, negative multipliers, and lag times.

2023 Q2 Key Ideas

Rising Budget Deficits

The U.S. Government budget deficit has taken a serious turn for the worse this year. The Inflation Reduction Act (IRA) and CHIPS and Science Act of 2022, as enacted, add over $1 trillion to the deficit over the next several years. The Penn Wharton Budget Model, however, indicates that due to the way instructions were written, the cost of the IRA is running three times greater than the amount appropriated by Congress. Current year federal tax revenues have also fallen considerably below a year ago. This is consistent with real gross domestic income (GDI) which fell in three of the last four quarters.

Increased interest payments and a short fall in tax revenues both add to the deficit, but they do not boost economic activity. Neither produce a new job, a new road, or a new dollar of research and development. More importantly, the lagged effects of the huge budget deficits of FY 2020-21 are likely to be negative due to the government expenditure multiplier.

Estimates from econometric studies of highly indebted industrialized economies indicate that the government expenditure multiplier is positive for the first four to six quarters after the initial deficit financing, then turns negative after three years. This implies that a dollar of debt financed federal expenditures will, ‘at the end of the day,’ reduce private GDP.

Successfully Time Tested

Two different rigorous studies, one completed in 2011 and the other in 2012, each using different methodologies, both concluded government fiscal policy actions that either increase the size of government relative to GDP or increase the government debt relative to GDP significantly weaken the trend rate of economic growth. The evidence, from more than a decade since this research was published, confirms those findings and indicates that the government multiplier is becoming increasingly negative.

Andreas Bergh and Magnus Henrekson (BH), writing in the peer-reviewed Journal of Economic Surveys in 2011, determined that a one percentage point increase in government size reduces the annual growth rate in real per capita GDP by 0.05% to 0.1% per year. Increases in government size means that more of the economy is being shifted away from the high positive multiplier private sector into the negative multiplier government sector.

When President Nixon closed the Gold Window, the 20-year moving average of the ratio of government size relative to GDP was 25.2% while the real per capita GDP/GDI average growth rate was 2.2%, which coincided with the average real per capita GDP growth rate since 1870. Based on the comparable numbers in early 2023, government size was a considerably higher 34.3%, and the growth in the real per capita GDP/GDI average was a much slower 1.3%. Thus, government size increased 9.1 percentage points and the real per capita GDP/GDI average growth lost 0.9% per year [Lead Chart]. Thus, the actual results, twelve years of which were beyond BH’s publication date, means the negative impact on economic performance was within 0.1% of BH’s top of the range.

Reinhardt, Reinhardt and Rogoff (RRR)

The Reinhardts (Carmen and Vincent) and Kenneth Rogoff, published in the Journal of Economic Perspectives in 2012, found that when gross government debt exceeds 90% of GDP for more than five years, then economies lose 1/3 of the trend rate of growth. Gross U.S. government debt moved decisively above this 90% threshold ten years ago. As previously stated, the trend rate of growth of real per capita GDP since 1870 is 2.2%. Over the last twenty years the average growth rate has fallen to 1.3%, a loss of slightly more than 1/3 of the yearly growth rate even though the last twenty years included some years in which the debt ratio was not above 90%. If the U.S. economy were on trend, real per capita GDP would be approximately $73,000, almost $13,000 higher than the actual level. RRR also argued that the deleterious effects of high debt levels would build even before reaching the 90% threshold, and indeed they did. This finding leads to the causal explanation that the overuse of debt reflects the law of diminishing returns.

Productivity

Productivity, or output per hour in the nonfarm sector, declined by a record pace over the past ten quarters. Neither a rising standard of living nor increasing corporate profitability are achievable over time without higher productivity. Since January, non-farm payrolls have increased by 1.2 million, but the average workweek has dropped from 34.6 hours to 34.4 hours, leaving aggregate hours worked virtually unchanged. To restore productivity, firms will need to rationalize their workforce, which will simultaneously reduce labor costs, inflation and household purchasing power.

The above paragraphs from Lacy Hunt highlight some of my recent articles on the ridiculously named Inflation Reduction Act, Industrial Production, and declining productivity.

Labor Productivity vs Costs

Labor Productivity vs Costs Long Term

Productivity Dead Zone

A huge wave of boomers retirements is in progress. Skilled boomers are now replaced with unskilled Zoomers (generation Z), who do not seem to have the same work ethic.

So, it’s no wonder productivity is in the gutter.

For discussion, please see Four to Six PM and Friday Afternoons Are a Productivity Dead Zone

The Fed Reports Abysmal Industrial Production Numbers and Negative Revisions Too

Recession Lead Times From IP Peaks

In yet another sign of a weakening economy, the latest industrial production report was an outright disaster.

The Bloomberg Econoday consensus estimate was unchanged in May from June. Instead, Industrial production fell 0.5 percent and the Fed revised May from -0.2 percent to -0.5 percent.

For discussion, please see The Fed Reports Abysmal Industrial Production Numbers and Negative Revisions Too

EVs

Also note that Despite Huge Incentives, Supply of EVs on Dealer Lots Soars to 92 Days

Why build cars that nobody seems to want?

President Biden can mandate ridiculous rules, but he cannot force people to buy EVs.

Largest Discrepancy Between GDP and GDI in 20 Years

Economists have given up on the idea of a strong recession, if indeed any at all. That’s despite the fact that GDI suggests a recession may have already started.

Note that we have the Largest Discrepancy Between GDP and GDI in 20 Years

It would be a hoot if recession started just as economists finally gave up on the idea of one happening.