In a note published earlier this week, Bank of America economists examined why fiscal stimulus is waning despite persistent large deficits.
The bank’s latest US Economic Weekly notes that the slowdown in private and public investment in the first quarter of 2024 signals that last year’s significant fiscal stimulus is now waning.
“We were not surprised by this development as we argued that the fiscal stimulus was likely to be broadly neutral this year,” economists said in a note.
A common question from clients is why fiscal policy does not continue to support economic growth given “unsustainable” deficits. In efforts to address these concerns, BofA clarifies that “the level of GDP is related to the size of the deficit, but GDP growth is a function of the change in the deficit from the previous year. “
“We think the confusion arises because the deficit is widely believed to be a flow variable, but GDP is sometimes mistaken for a share, when in fact it is also a flow,” economists added.
They further explain that large deficits do not necessarily translate into sustained economic expansion. Typically, a substantial fiscal expansion results in a level shift in GDP. However, if the deficit remains stable or subsequently shrinks slightly, the impact of fiscal policy on GDP growth (the fiscal impulse) could shift from strongly positive to flat or even negative.
Citing comments from Fed Chair Powell, the current fiscal path may be “unsustainable,” but this does not mean fiscal policy will remain expansionary, the BofA team explained.
To illustrate this point, BofA points to the primary deficit ratio, which is currently eight-tenths below the same period a year ago, “suggesting that federal fiscal policy is holding back growth despite high deficit levels,” the bank said. said.
