Fiscal policy and supply


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Economic growth in the United States has not been very strong since before the Great Recession that ended in June 2009.

The economic recovery following the Great Recession has seen economic growth at a post-global level World War II expansionist bass.

Between July 2009 and February 2020, economic growth in the United States only reached a compound rate of 2.3%. This is the slowest economic recovery since the war period.

Economic thought holds that one of the most important components of economic growth is the growth rate of labor productivity.

One of the slowest periods of labor productivity growth occurred in the period following the Great Recession. Here is the table of this performance.

Labpr Productivity

Non-farm labor productivity (Federal Reserve)

Note that there is always an upward “bump” in labor productivity growth following a downturn in the economy. This has been true of all business cycles since the end of World War II.

The important parts of the chart, for our purposes, are the periods following this “hump” when the economy returns to more regular activity.

These “bumps” can be seen after both periods after the end of recessions occurring during this period.

Labor Force Participation

One final thing should be noted when examining labor productivity growth.

The productivity that has been achieved has been accompanied by a decline in the labor force participation rate.

That is, real labor productivity growth is increased because workers have left the labor force.

Labor force participation rate

Labor force participation rate (Federal Reserve)

During the period considered, the actual productivity that was achieved was increased by the fact that the work was carried out by fewer and fewer people.

This is particularly notable at the time of the Covid-19 recession in 2020.

The point: labor productivity growth during this period was abysmal. The supply side of the economy was doing almost nothing in the period following the Great Recession.

During the period from 2010 to 2018, the “average” annual rate of increase in labor productivity was 0.7%… not even 1% per year!

Between 2000 and 2007, the labor productivity rate in the United States was 2.6%. And, in the period from 1990 to 2000, the growth rate was 2.2%.

Something has changed. I have written about this many times before and believe that the more we learn, the more this slowdown in US economic growth is due to a change in government economic policy.

Change in economic policy

Economic policy changed after the Great Recession. I believe this has led to a vast slowdown in US economic growth.

The primary focus of monetary policy emerging from the Great Recession was that created by Fed Chairman Ben Bernanke, and it came to dominate US government economic policy in the 2010s.

Mr. Bernanke shifted monetary policy towards financial assets rather than physical assets.

In particular, Mr. Bernanke wanted the Fed to move stock prices in order to create a “wealth effect” that would encourage consumers to spend. But the boost in stock prices has also ignited a fire under the price of many other assets like real estate and gold. The 2010s saw many asset price bubbles.

In addition, consumer spending was stimulated and the economy grew.

But economic growth has been modest at best.

The stimulus came from rising asset prices. Sophisticated investors saw this and turned to asset markets rather than things that drove labor productivity growth.

As I have written many times over the past decade, this result was essentially the culmination of trends that began in the 1960s. I have called this approach to economic policy “credit inflation.” .

But, things really changed when Bernanke started shifting his monetary policy in that direction. And, Mr. Bernanke led the Federal Reserve through three rounds of quantitative easing before leaving his post at the Fed.

Basically, when Mr. Bernanke left office, the commercial banking system was full of cash.

Fiscal policy follows

The federal government’s fiscal policy didn’t stop there…spending exploded.

government spending

Federal government spending (Federal Reserve)

As can be seen in this extended chart, federal government spending really took off during the period of the Great Recession, just as Mr. Bernanke went through three rounds of quantitative easing.

The federal government’s response to the threat of Covid-19 has been enormous.

And budget deficits have increased. The debt burden has increased.

Debt percentage

Total federal debt as a percentage of GDP (Federal Reserve)

Note that total federal debt as a percentage of gross domestic product exploded during the Great Recession and then continued to rise throughout the following recovery.

In the 2020s, the percentage has increased further.

It seems that the success of this debt growth was a result of the fact that, as explained above, more and more government stimulus money was being invested in assets like stocks and bonds, not in uses. productive as real investment in physical capital for businesses.

Indeed, sophisticated investors were looking for capital gains, not real returns on productive assets.

In support of this, we see that income and wealth inequality have increased enormously over this fifteen-year period beginning with the Great Recession.

The Federal Reserve and the Federal Government were creating “capital gains” from investment in assets, but they were not creating increasing participation in the rest of the economy through increased labor productivity, which contributes to the rise in real wages, and other aggregate returns within the economy. economy that has spread to all.

The main beneficiaries were investors who benefited from the rise in asset prices, but not from economic growth.

Have times changed?

Many analysts believe that times have not changed. They still expect inflation to return to more reasonable levels. They expect the stock market to continue to rise. They expect continued government spending to push the economy forward rather than raise prices.

The test these analysts give is that if the expected real growth of the economy is greater than the real cost of borrowing, then the budget deficit should continue.

The real cost of borrowing is defined as the nominal interest rate minus the real inflation rate.

Currently, the yield on the two-year US Treasury bill is 4.25%.

The latest inflation figures, as represented by the PCE price index, in August were 6.2%, year-on-year.

Thus, the real growth rate of the economy would have to be at least 4.25% to equal the “real” cost of borrowing.

For these analysts, the cost of borrowing is therefore much lower than the real return obtained by real economic growth. So government spending MUST be worth going forward.

And, so, the advice is to go ahead and keep spending and creating federal deficits.

What happens?

Well, the debt burden is getting bigger and bigger and bigger.

Economic growth remains modest at best because investment goes into asset prices rather than productive capital.

And, incumbent politicians keep getting re-elected because of all the spending programs they support that they believe will spur the economy to greater growth.

That’s a far cry from what really works…balanced budgets and supply-driven economic programs. Spending, spending, spending won’t get you there.

But, more on that later.


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