The US budget deal announced in December 2013 will continue to slow the recovery by locking in procyclical fiscal policy, as measured by a trend toward surplus in the primary structural balance

1. Economics for your Classroom from
Ed Dolan’s Econ Blog
US Budget Deal Locks in
Tight Fiscal Policy
Posted December 12, 2013
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2. The December Budget Deal
Senator Patty
Murray
 In early December Senator Patty
Murray (D-WA) and Representative
Paul Ryan (R-WI) reached a
proposed budget deal that would set
U.S. fiscal policy for the next two
years
 Main points:
 Relaxes “sequester” restrictions
 Small increases in some spending
programs
 Spending increases offset by
increases in government fees
 Little change (slight reduction) in
overall deficit projection
Representative
Paul Ryan
December 12, 2013 Ed Dolan’s Econ Blog

3. Government Contribution to GDP Growth
 The budget deal comes at a time
when the federal government’s
contribution to GDP growth has
been negative for 10 of the past 12
quarters
 For most of that time, state and
local government has also made a
negative contribution to growth
 The negative growth contribution
means that fiscal policy has, on
balance, slowed the recovery
December 12, 2013 Ed Dolan’s Econ Blog

4. Federal Employment
 Total federal employment
provides another perspective on
the trend in fiscal policy
 Since the expiration of the
temporary stimulus of 2009 and
temporary census hiring in
2010, federal employment has
been falling
 It is now lower than at any time
during the previous presidential
administration (2001-2009)
December 12, 2013 Ed Dolan’s Econ Blog

5. Primary Structural Budget Balance
 The broadest measure of the
stance of fiscal policy is the
primary structural balance
(PSB)—the deficit or surplus at all
levels of government adjusted for
both interest payments and the
state of the business cycle
 On the downslope of the
recession, Bush and Obama
stimulus programs moved the
PSB toward deficit
 The PSB has been moving back
toward surplus since the recovery
began in mid-2009, showing a
trend toward tighter fiscal policy
December 12, 2013 Ed Dolan’s Econ Blog

6. The Output Gap
 The economy’s output gap is a
useful reference point for
evaluating fiscal policy
 The output gap is the difference
between the actual level of GDP
and the level that the economy
could produce if it operated at its
potential real output
 For the U.S. economy, potential
real output would correspond to
an unemployment rate of about 6
percent
December 12, 2013 Ed Dolan’s Econ Blog

7. Neutral, Countercyclical, and Procyclical Fiscal Policy
The relationship between changes in the primary structural balance (PSB) and the
output gap over the business cycle defines three types of fiscal policy:
 If the PSB is constant over the course of the business cycle, the actual budget
will move into deficit when the economy dips into recession and into a larger
than normal surplus during a boom. That pattern of policy is cyclically neutral.
 A countercyclical fiscal policy attempts to smooth the business cycle by using
discretionary tax cuts or spending increases to move the PSB toward deficit
during a recession, and by using tax increases and spending cuts to prevent
overheating during a boom.
 A procyclical fiscal policy amplifies the business cycle rather than smoothing it.
It does so by using tax increases and spending cuts to move the PSB toward
surplus when the economy is operating below potential and then cutting taxes
and increasing spending in times of prosperity.
December 12, 2013 Ed Dolan’s Econ Blog

8. US Fiscal Policy Has Been Procyclical During the Recovery
 Since the recovery officially began
in mid-2009, US fiscal policy has
been strongly procyclical
 Although the output gap has been
negative, the primary structural
balance has moved sharply toward
surplus
 This procyclical fiscal policy has
slowed the recovery from the Great
Recession and is projected to
continue to slow it
December 12, 2013 Ed Dolan’s Econ Blog

9. The Bottom Line
 The Murray-Ryan budget detail
changes some details of spending
and revenue but leaves the
trajectory of current and projected
primary structural balances largely
unchanged
 Because it locks in procyclical
fiscal policies, it can be considered
a victory for fiscally conservative
“deficit hawks.”
 The deal is likely to mean that the
recovery will continue to be a slow
one
December 12, 2013 Ed Dolan’s Econ Blog

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