Friday, March 2, 2012

The austerity recovery

Both Europe and the US have witnessed so far very weak recoveries from the past recession. There are many reasons why the recovery has been unusually slow: a weak real estate market, debt overhang, the fear of sovereign crisis. Some of these arguments are hard to quantify but there is one factor that is much easier to measure: the role of fiscal austerity. Although it is easy to measure, the facts seemed to have escaped the public debate for months. For a while it was common to hear the perception that government spending was constantly increasing due to successive stimulus packages approved by governments. More recently there is growing concern with the potential role of austerity in slowing down the recovery but so far it has not triggered any clear action.

Here are three charts summarizing some key facts for the US economy. I compare below the last two recoveries: the one that started in the fourth quarter of 2001 with the one that started in the second quarter of 2009. Just to be clear, the 2001 recovery was also a slow one from a historical point of view, but it still can be an interesting benchmark. What you see below are levels relative to the quarter when the recovery started (variables are in nominal terms).

We start with GDP and we can see that 11 quarters after the recovery had started the economy was doing significantly better in the 2001 recovery than in the current one. So this recovery is even slower than the "slow" 2001 recovery.

But what if we just exclude the government sector and only measure non-farm private business sector output. The chart below shows that the two recoveries look similar from today's perspective. The 2009 recovery was stronger in the first quarters but 11 quarters after the recovery had started we are in the same position.

And finally, what about the role of governments. I plot below government consumption and investment (which are the two components of governments that enter the GDP calculations) for the last two recoveries. Here the difference is striking. While government spending was strong during the 2001 recovery growing by about 16% in the 11 quarters that follow - faster than other components of GDP; in the 2009 recovery government spending has barely grown and has remained flat or even falling over the most recent quarters. 

The analysis I am doing is clearly not complete. Each of the variables I plot are not independent. The behavior of private business output depends on government spending. How private output reacts to government spending is a source of debate as the answer depends on what economic theories you believe about the fiscal policy multiplier. But that debate cannot change the simple accounting exercise that the previous three plots do. Compared to previous US recoveries, the current one is unusual in the sense that government spending (a component of GDP) has been much weaker than in previous recoveries.

Antonio Fatás