US Fiscal Stimulus at odds with Monetary Tightening
As the US Federal Reserve has raised its interest rates over the past year the US economy has remained strangely robust. This is partly due to the time it takes for the effects of interest rate rises to flow through to all of the economy, a policy lag effect that can be as much as a year. In addition, the post-COVID worker shortages may have made corporations more reticent about layoffs, especially when profit margins have been expanded under the cover of higher inflation. On top of that there has been an exuberant stock market counter-trend rally that has kept the dreaded “wealth effect” impact on higher income consumption at bay. A major cause of the ongoing robustness of the US economy is that the US government is “fighting the Fed”, by increasing fiscal stimulus and by keeping oil prices lower than they would otherwise be through an ongoing draining of the US Strategic Petroleum Reserve (SPR). It is also important to understand that much of the aid given to Ukraine actually ends up getting spent with the US Military Industrial Complex in the US.
Using the deficit tracker provided by the Bipartisan Policy Center, we can see that the cumulative deficit for fiscal year 2023 (which started in October 2022) was US$928 billion up to and including April, compared to a cumulative deficit of US$360 billion in the previous year to April; a difference of US$568 billion (a fiscal stimulus of approximately 2% of US GDP in only 7 months!). This was caused by a fall in receipts and an increase in spending, both of which resulted in a fiscal stimulus to the economy. Part of the extra spending (US$39 billion) was for the bailout of all of the deposit holders of the recently failed banks; which both rescued a significant number of well-connected rich people and in the short-term stopped any further impact on the venture capital industry and higher income groups in general. Another US$107 billion was for increased interest payments on the federal debt, much of which flows through to higher income earners, US$48 billion for the ongoing pause in student loan payments, US$33 billion for increased defence spending and US$35 billion for COVID-related increased Medicaid eligibility which is now ending. The continued draining of the SPR has also kept gasoline prices lower than they otherwise would be, reducing costs for a heavily car and truck dependent nation. Consumption has also been aided by the IRA subsidies for the purchase of an electric vehicle, which are up to US$7500 per vehicle (even more with additional state subsidies), the full impact of which will not be seen until next year’s tax filings.
The fiscal year 2022 deficit was approximately US$1.4 trillion (about 6% of GDP) during a year of growth in the economy, and fiscal 2023 looks on track to be significantly above that as the interest rate rises work their way through the economy (including rises in US government interest costs as more debt is issued and previous debt has to be refinanced). With a Republican majority in the House of Representatives we have already seen attempts to cut spending on the poor and moderately well off, all of which tends to be spent immediately rather than saved, during the manufactured “debt ceiling crisis”. As the economy starts to roll over in the second half of this year (a reality that many economic indicators are pointing towards), the US government deficit will start to rapidly increase due to lower taxes and higher spending on such things as unemployment benefits, plus the higher interest payments. This will be at the very time when the Republicans will be looking to limit spending that benefits the none rich, which may reduce the counter-cyclical effect as “entitlements” are cut. Such cuts will only make things worse though as the economy contracts more than it otherwise would have, producing a greater decrease in government revenues.
This will all be happening in the run up to the 2024 elections, possibly producing a rerun of the 2008 alignment of the GFC and elections. With the government deficit exploding probably well beyond 10% of GDP, further fiscal stimulus will not be an option. The result may be a Fed panic back to zero interest rates and massive QE in 2024 in an attempt to forestall a debt-deflation scenario (and a Trump landslide victory). At that point all policy options will have been exhausted, fiscal stimulus, zero interest rates and money printing, while we revisit the stagflation of the 1970s. Any “Volcker Shock” from the Fed would be off the table given the extremely high levels of public and private debt compared to the late 1970s. The US$ would be expected to depreciate significantly, increasing import costs and making it more expensive to fund the US war machine abroad, as well as devastating commodity exporters who will receive less local currency for each US$ of revenue in addition to US$ price falls for their exports.
The deflationary effects will then be transmitted to the rest of the world, with China not in a position to repeat the massive fiscal and credit increases that bailed out the world economy post-GFC. This would be devastating for an already heavily indebted Europe, which may also be experiencing a very cold El Nino winter that drives up natural gas prices to the levels seen in early 2022. Oil prices may also not fall as far as would be expected with a probable refilling of the US SPR together with possible production cuts from OPEC+. The 2020s may then feel much more like the 1930s, with increasing great power competition combined with an economic slump and possibly stagflation rather than deflation; a very bad mix in addition to an intensifying climate crisis.
https://bipartisanpolicy.org/report/deficit-tracker/#:~:text=Tracking%20the%20Federal%20Deficit%3A%20March%202022,month%20of%20fiscal%20year%202022.