Concerns that the U.S. is approaching a fiscal cliff next year prompted us to publish a rebuttal last Wednesday. A just-published report debunked the notion that fiscal policy will be a drag in 2022. In fact, it will still be providing stimulus to the economy.
The past 18 months has seen some unprecedentedly massive fiscal packages, and a blow-out in the federal budget deficit. The latter will indeed diminish significantly next year, but the public sector will still be a source of stimulus in terms of what impacts economic activity, i.e. government consumption and investment will increase again in 2022. In addition, there are good odds of yet another fiscal package.
The huge amount of government transfers to the private sector are not directly counted in GDP, only when the funds are actually spent. There is still a huge pool of household savings that is sitting in cash. Even as new government transfers slow, the pool of existing savings will be spent over time once consumers feel safer to move about more freely, and are able to return to prior spending habits (and the supply of goods and services returns to more normal levels). In the end, a good portion of the past year’s transfer payments will only spur greater consumption and investment with a long lag.
The critical longer-term impact is that the fiscal backdrop will be supportive going forward, representing a big change from last decade, when government consumption and investment growth turned negative after the initial recovery phase.