02-Feb-24 Americas

U.S. economic growth and fiscal balances

Amidst the excitement in markets about the strong growth performance of the U.S. economy, some nuance seems in order.

“All statistics are answers to specific and extremely narrow questions,” the economic historian E. J. Hobsbawn was fond of pointing out. If they are used to answer other questions, “they must be treated with extreme caution.”[1] Take the strong growth performance of the U.S. economy amid widespread recession fears throughout 2023, capped by the latest figures for the fourth quarter.[2] Amidst the excitement in markets, some nuance seems in order.

Throughout 2023 nominal U.S. economic growth was about 5.8% on average, according to the latest reading, partly boosted by higher inventories. To put this in context, our Chart of the Week shows the seasonally adjusted nominal change in gross domestic product (GDP) year-over-year compared to the cyclically adjusted primary balance of the U.S. government as a percentage of potential GDP.

U.S. growth performance compared to cyclically adjusted government deficits

Sources: BEA, OECD/Haver, DWS Investment GmbH as of 01/31/24

Admittedly, early GDP readings for each quarter tend to be quite revision-prone, while many of the underlying estimates and adjustments are more art than science in the best of times.[3] Still, it is interesting to note that at 3.9% of GDP, the U.S. government ran a deficit about 2.5% larger than in 2022, even after correcting for the business cycle. Assuming just a moderately effective fiscal multiplier (say, somewhere in the region of 0.5 – 0.75%), that would suggest that a sizeable chunk of last year’s growth surprise was due to Uncle Sam running such a large deficit.

The reality is probably quite a bit more complicated. Fiscal impulses should not be confused with fiscal policy multipliers.[4] In this particular instance, the reason behind the larger deficit appears to largely come down to falling tax revenues, rather than higher government spending.[5] Some of these will hopefully reverse – notably, lower capital gains taxes reflected weak capital markets performance in the first ten months of 2023. In other areas, there are also time lags; for example, various annual inflation adjustments to tax provisions appear to have temporarily reduced income taxes, for those whose earnings have yet to catch up with inflation.[6]

“The bottom line is that it is too early to say how much momentum to really read into those latest GDP growth figures,” argues Christian Scherrmann, U.S. economist at DWS. “No wonder that the Federal Reserve (Fed) keeps emphasizing how data-dependent its monetary policy decisions look set to remain for the foreseeable future.”[7]

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1. Hobsbawn, E.J. (1969), „Industry and Empire“, Pelican Books, p. 11.

2. US economy defies recession fears with 3.3% growth in fourth quarter (ft.com) Issue 01/25/2024

3. Since the start of the pandemic, even such usually simple tasks as seasonal adjustments have at times proved quite tricky. See, for example, Goodhart, C. and Pradhan, M. (2020). The Great Demographic Reversal: Ageing Societies, Waning Inequality and an Inflation Revival. Palgrave Macmillan, pp. 214

4. Fiscal Impulse in: IMF Working Papers Volume 1991 Issue 091 (1991)

5. No need to panic about the budget deficit | Brookings Issue 09/20/2023

6. IRS Announces Inflation Adjustments for Tax Rates in 2023 - The New York Times (nytimes.com) Issue 10/18/2022; for further details, see: IRS provides tax inflation adjustments for tax year 2023 | Internal Revenue Service Issue 10/18/2022

7. Federal Reserve Board - Federal Reserve issues FOMC statement

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