One Big Reason the US Economy Has Been So Sluggish

Plus, Trump vs. the Fed By Yuval Rosenberg and Michael Rainey Government Has Been a Drag on the Economy – but That’s About to Change The U.S. economy is about a year away from breaking the 1990s record for the longest expansion in U.S. history — and yet the recovery from the Great Recession has also been among the weakest growth periods since the end of World War II. In a new research note, economists at Bank of America Merrill Lynch lay most of the blame for that on government spending — or a marked lack thereof: Disappointing growth has been attributed to a number of factors, including the structural damage wrought by the financial crisis, demographic headwinds and global shocks (e.g., the Eurozone sovereign debt crisis of 2011-12 and the EM slowdown of 2016). But we find that public sector spending alone goes a long way in explaining the growth slowdown. In fact the performance of the rest of the economy in this cycle has been remarkably similar to the previous cycle. Just how massive a drag has the public sector been on the economy? Merrill Lynch economist Aditya Bhave writes that federal, state and local spending collectively account for about 17 percent of GDP, and spending across all three levels of government has declined at a 0.6 percent annualized, inflation-adjusted rate since the middle of 2009. Private-sector GDP, meanwhile, has grown at a faster 2.9 percent clip, or above 3 percent if you take out a dip in late 2015 and early 2016. That’s still slower than private-sector growth in previous expansions, continuing a slowdown that was also seen during the expansion from 2002 to 2007, Bhave writes, “likely due to unfavorable demographics and a structural decline in productivity growth.” Economists, including those at Merrill Lynch, largely agree that the combination of tax cuts and spending increases passed by Congress since late last year will provide a temporary, short-term boost to GDP growth. Merrill’s Bhave says real government spending will grow by 1.9 percent this year and 2.4 percent in 2019, helping GDP growth reach 3 percent annually for the first time since 2005. Another Bank of America Merrill Lynch economist, Joseph Song, says that Congress’ deal earlier this year to raise federal spending by nearly $300 billion above existing caps has yet to hit the economy, but most of the expected boost to growth should become visible in the data over the second half of this year and the first half of 2019: The data suggest fiscal stimulus has yet to kick in from the higher spending caps agreed upon earlier in the year. Defense spending saw a modest uptick in 2Q but well off the projected annual pace. Reliable data on nondefense spending are hard to come by but the projections by the CBO suggest that the strength seen in 1Q should carry forward. Put together, the bulk of the fiscal stimulus should be felt over the next 4 quarters. The bottom line, according to Song: “look for the government sector to be a tailwind for the economy reversing the decade-long trend of being a drag on the economy.” Why it matters: Most economists still contend that the extraordinary deficit-financed stimulus at this stage of the economic cycle won’t provide much more than a temporary sugar rush for the economy, but the Merrill Lynch data provides some valuable insights into why the U.S. has been in a slow-growth rut. [Share this story →]( But Will the Fed Take the Wind Out of the Sails? Bloomberg’s Jonathan Bernstein [says]( that President Trump’s policies have been focused largely on short-term economic gains, and their effects — namely higher growth and higher deficits — will push the Federal Reserve to raise interest rates as it attempts to deal with rising inflation and ever-expanding federal debt: [Trump’s] preferred combination of loose fiscal and monetary policy — of large federal budget deficits along with low interest rates — also may run up against reality. The Fed isn’t just randomly imposing higher interest rates; its actions are a perfectly predictable (and, most economists would say, responsible) reaction to continued growth and those enormous federal budget deficits that Trump and congressional Republicans have created. Similarly, Bloomberg’s Ramesh Ponnuru [warns]( that the Fed’s monetary policy may end up limiting the boost provided by fiscal policy: The Fed offsets the impact of changes in the deficit even if its policymakers are not consciously trying to do so. The central bank need only respond in roughly consistent ways to trends in unemployment, inflation and other economic variables for its behavior to counteract fiscal stimulus. Ponnoru says that, in the end, the U.S. will be left with a “bigger national debt, which comes with an obligation to pay greater amounts of interest.” Tweet of the Day A day after courting controversy by saying he’s “not thrilled” with the Federal Reserve raising interest rates, President Trump once again criticized the central bank’s rate hikes in a tweet on Friday morning. Some additional context: Interest on the national debt is the [fastest growing]( part of the federal budget, and the Congressional Budget Office projects that interest costs will roughly [double]( as a share of GDP (from 1.6 percent to 3.1 percent) over the next decade as rates rise from their recent historic lows. CBO says interest costs are on pace to exceed all federal discretionary spending by 2045. And the Committee for a Responsible Federal Budget [said]( earlier this year that, for every percentage point that interest rates rise above what CBO projects, the amount spent on interest would grow by nearly $2 trillion over 10 years. State Health Care Mandates Would Reduce Premiums, Study Finds Health insurance premiums in the federal marketplace would cost 11.8 percent less in 2019 if all 50 states adopted coverage mandates, according to a new [study]( from the Commonwealth Fund and the Urban Institute. Additionally, 3.9 million more Americans would be covered by insurance next year, and 7.5 million in 2022, compared to projections under current law. The mandate requiring individuals to have health insurance was imposed at the federal level by the Affordable Care Act but the Republican tax law effectively eliminated it starting in 2019. The end of the mandate, which was controversial politically, comes with a significant cost in terms of lower coverage levels and higher premiums. According to the Congressional Budget Office, 3 million fewer people will have health insurance in 2019 as result of nixing the individual mandate penalties, and premiums in the individual marketplaces will rise by roughly 15 percent. The mandate was designed to bring more healthy people into the insurance pool, thereby lowering the overall cost of care. Some states are looking into imposing their own mandates in order to boost enrollment and reduce costs. Massachusetts and New Jersey have already done so. The Commonwealth study projected changes in overall coverage and cost that would result if all states imposed individual mandate penalties, although there is no indication that a substantial number of states are planning to do so. Happy anniversary to President Trump. It's been 18 months since he took office. And yes, we said months. Send us your thoughts and feedback by emailing yrosenberg@thefiscaltimes.com. Follow us on Twitter: [@yuvalrosenberg]( [@mdrainey]( and [@TheFiscalTimes](. And please tell your friends they can [sign up here]( to get their own copy of this newsletter. Your Prize for Making It Through the Week Once upon a time, people had to carry cameras with them if they wanted to capture a sunset or a snapshot of their kids at the beach, and almost no one took pictures of their daily lunch, or selfies at tourist hotspots. But the iPhone changed all of that, merging a communications device with a plethora of other functions, including an increasingly powerful camera. 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