Sudeep Reddy provides five reasonsWhy Economists Are Betting A Recession Won’t Happen. These reasons are ably summarized in the WSJ Real Time Economics Blog post Five Reasons Recession May Be Averted:
- The Fed is on the case.
The Fed, which has cut its main target for short-term interest rates by a full percentage point since August, is expected to ease rates through the middle of next year to cushion the economy from housing and credit woes, and officials are experimenting with new tools in an effort to ease the credit crunch and encourage banks to keep lending to worthy borrowers.
- Strong global growth is propping up the U.S. economy.
Global economic growth is raising demand for U.S. goods, offsetting softer domestic consumption. Emerging markets, which buy more than half of U.S. exports, continue to grow, some at an accelerating pace, even as industrialized economies cool.
- The economy is still creating jobs, supporting incomes.
The job market is signaling a modest slowdown in hiring but not a sharp increase in layoffs. While jobs continue to bleed from the housing and finance sectors, growth in service jobs remains robust and most other sectors remain afloat.
- The housing downturn’s pain will continue, but has already done much of its damage to growth.
One of the biggest questions hanging over the economy remains: How far is the housing market from its bottom? Though many major markets are experiencing steep price declines, much of the country is OK. The S&P/Case-Shiller index, a popular measure of home prices that has shown steep price declines, has limited geographic coverage — perhaps overstating the extent to which the housing sector’s declines will weigh on consumers.
- Government spending remains strong.
And then there is the government — not just Washington but state and local governments. Spending by state and local governments is contributing 25% of GDP growth this year — and that is before an election year when officials will resist making cutbacks. It tends to lag federal spending and should continue to perform well next year even if it slows in 2009, he says.
There’s plenty to discuss here, and some of it is well trodden ground. But I want to focus on the last point, which I hadn’t seen before, partly because I found it surprising.
State and local government spending, as I learned it in the macro textbooks, is procyclical. That’s because the borrowing capacity of state and local government is constrained, and with the advent of state balanced budget requirements, is increasingly constrained (although in principle state and local governments can save).
The following figures present the state and localspending shares of GDP (total expenditures, and consumption) on a NIPA basis, and the associated budget balance.
Figure 1: State and local government current expenditures (blue) and consumption (red), on a NIPA basis, as a share of nominal GDP. State and local spending calculated as the difference between total government and Federal series. NBER-defined recessions shaded gray. Source: BEA GDP release of 29 November 2007, Tables 3.1 and 3.2, NBER, and author’s calculations.
Figure 2: State and local government budget balance calculated as the difference between receipts and current expenditures, on a NIPA basis, as a share of nominal GDP. State and local spending calculated as the difference between total government and Federal series. NBER-defined recessions shaded gray. Source: BEA GDP release of 29 November 2007, Tables 3.1 and 3.2, NBER, and author’s calculations.
Figure 1 is interesting in that the spending ratio (either total or consumption) does does seem to rise in recessions. However, I would argue that that characterization arises in part because the denominator (nominal GDP) is declining. Figure 2 shows that state and local government budget balances quickly switched from surplus to deficit in 2000-01. While the deficits appear large, they are only half a percentage point of GDP at the peak (essentially a spike in 2003). Further, note that unlike 2000, there is no buffer. The combined state and local governments are near balance…
Returning to the expenditures side, another way of showing what happens to spending is to deflate spending, and calculate the year-on-year change (log differences). I use the GDP deflator (not because of any particular reason, just for simplicity). One can see that there is a wide diversity of experiences over the various recessions.
Figure 3: Year-on-year change in real state and local government current expenditures (blue) and consumption (red), on a NIPA basis. State and local spending calculated as the difference between total government and Federal series. GDP deflator used to convert to real terms. NBER-defined recessions shaded gray. Source: BEA GDP release of 29 November 2007, Tables 3.1 and 3.2, NBER, and author’s calculations.
I would argue that in the last recession, the real state and local spending (particularly consumption) was in part sustained because of spending associated with the post-9/11 security measures. That support is unlikely to be present should another recession occur.
Indeed, working in the opposite direction, one might imagine the procyclicality might be further exaggerated by the big surge in property taxes and fees associated with the housing boom. As that boom (both residential, and possibly commercial) further dissipates, one might anticipate a precipitous drop in state and local revenues and consequently spending. So, for my money, I’ll put more weight on the first four reasons.
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