If fiscal policy is important at the zero lower bound, why did
the US recovery continue in 2012 and 2013 despite a large fiscal contraction?
Or to put the same question in a comparative way, why was the Eurozone’s fiscal
contraction in 2012/3 associated with a recession, but not in the case of the
US?
GDP growth had been reasonable in both the US and the EZ in
2010 and 2011. While US growth continued into 2012/3, EZ growth collapsed. Yet
as the chart above shows, fiscal tightening was only slightly greater in the EZ
in 2012, and became considerably tighter in the US in 2013.
Before discussing this, it is important to make two important
points. The first is that the macroeconomy is complex, involving important lags
in behaviour and expectations of future events. For that reason alone, you will
not get precise matches between causes and consequences by just eyeballing the
data. Second, different fiscal measures have different effects, and trying to
express the fiscal stance in one simple measure will always be a crude
approximation. However, despite these qualifications, I think we can provide
something of an answer to this question by just looking at the numbers.
In comparative terms, there are two obvious answers looking at
2012. The first is the EZ crisis. Although this began in 2010, it reached a
critical position in 2012, when Greece was almost forced out. It is hardly
surprising in these uncertain circumstances that EZ investment fell by nearly
4% in 2012. The second is monetary policy. The ECB raised rates from 1% to 1.5%
in 2011, and compared to the US there was no Quantitative Easing. Combining the
two, monetary conditions tightened considerably in the periphery as a result of
the crisis. There was no comparable crisis in the US, which allowed investment
to increase by 5.5%.
Explaining 2013 seems more difficult. Monetary policy had eased
in the EZ (although of course not by as much as it should have), and OMT had brought the crisis
to an end. In the US there was considerable fiscal tightening. So
why did the US continue to grow and EZ GDP continue to fall?
For the EZ one proximate cause was a sharp decline in the
contribution of net exports. Net exports added 1.5% to GDP in 2012, but only
0.5% in 2013. If this contribution had been more even at 1% in each year, GDP
would have fallen by over 1% in 2012, and stayed roughly flat in 2013. Fiscal
policy continued to tighten, which also would have reduced growth.
In the US something else happened: the savings ratio, which had
been elevated at 5.5% or above since 2009, fell to 4.5%. This could have been a
result of fiscal tightening, but it seems more probable that it represented the
end of a prolonged balance sheet correction. (The US savings ratio averaged
4.5% between 1996 and 2007 and the OECD’s forecasters expect it to fall further
this year and next.) The OECD estimates that the US output gap in 2013 was
-3.5%, which was much the same as their estimate for 2012. So growth of 2% did
nothing to close the output gap in 2013. This was despite a large fall in the
savings ratio, perhaps bringing to an end the balance sheet correction that
began with the Great Recession. So US growth in 2013 should have been very
strong, and the obvious explanation for why it was not is very restrictive
fiscal policy.
