U.S. government purchases measured in constant buying power dollars (or real government purchases) fell in the third and fourth quarters of 2020 according to estimates from the U.S. Bureau of Economic Analysis (BEA). Government purchases are often abbreviated in algebraic expressions of economics variables by G. Not only did real government purchases in the U.S. in total decrease, but disaggregating G into (1) federal government purchases and (2) state and local government purchases reveals that both of these two categories in real terms decreased in the last two quarters. Measured instead in nominal terms with dollars of varying buying power that changes as prices in the economy change, U.S. nominal government purchases increased only relatively modestly in the fourth quarter of 2020 after decreasing somewhat in the third quarter. Why is this important?
Government purchases refer to expenditures by a government sector for newly made goods and services, including the labor services of government employees. Unlike government transfer payments such as social security and unemployment compensation, government purchases count toward gross domestic product (GDP). Government transfer payments do not count toward GDP because no good or service was produced in exchange for the payment from the government.
GDP estimates the value of all of the goods and services produced in an area (like the U.S.) in a time period (in the U.S, either a quarter or a year). For more about GDP than is in this blog entry, readers can refer to principles of macroeconomics and intermediate macroeconomics textbooks.
One stabilization policy tool that the government has to increase real GDP is government purchases. Other tools are tax reductions, increases in government transfer payments, increases in the money supply (or the money supply growth rate), and reductions in interest rates. Changes in taxes and government spending are fiscal policies, while changes in interest rates and the money supply are monetary policies. Because the U.S. economy has yet to recover fully from the contraction in the first two quarters of 2020 (based on my calculations using U.S. BEA data from the Saint Louis Fed webpage FRED), why would policymakers allow G to fall (at least in real terms)? The book that I am currently completing suggests that by at least two measures, the U.S. economy may not have fully recovered from the Great Recession, let alone the COVID-19 economic catastrophe. One advantage of increasing government purchases over increasing government transfer payments and reducing taxes is that by definition, increases in government purchases guarantee that the income received due to providing government purchases is spent at least once in a GDP transaction, while changes in income due to tax reductions and government transfer payments could be saved, and thus not directly increase GDP.
GDP can be expressed as the sum of consumption (bought by households), investment in physical capital (done largely by businesses), government purchases (made by the government sectors), and net exports (or exports minus imports, with those in other countries buying exports from the domestic economy). Algebraically, GDP = C + I + G + NX. The fact that government purchases in the U.S. at least in real terms were allowed to fall the last two quarters before the economy had fully recovered calls into question the commitment to ending the recession and improving the lives of millions of people. Did policymakers think that consumption, investment in physical capital, and/or net exports would rise sufficiently to return real GDP back to its pre-recession level despite a decrease in G in real terms? A bit more about this appears below.
Money supply growth in the U.S. was relatively high in the fourth quarter of 2020 based on data from the St. Louis Federal Reserve Bank’s FRED web page. Given that policymakers at the very least implicitly allowed government purchases to fall (sometimes only in real terms) while money supply growth was relatively high raises the issue of whether the U.S. at least implicitly at a minimum from time to time relies mainly on expansionary monetary policy to complete economic recoveries.
Regarding rapid money supply growth, my previous blog entry (available at https://harrisonhartman.blogspot.com/2021/02/why-decrease-in-us-m1-money-velocity.html) pointed out that the U.S. M1 money supply has more than quadrupled from December 2007 to December 2020. Where is all of this money going? Although expansionary monetary policy over decades has clearly helped in increasing real GDP and it may possibly have lessened the severity of and even prevented one or more financial crises, has such expansionary monetary policy been completely successful in restoring lost real GDP and lost employment? Would it be better for fiscal policy to take the lead and not allow G to fall until the recovery is complete, if ever allowing G to fall?
Strategic fiscal policy can help to get dollars to be spent and to reduce inequality. By stimulating spending, fiscal policy could at least help to reduce the rate of decline in the velocity of the M1 money supply in the U.S. It could also provide income to those who need it the most and those most likely to spend it. Regarding economic inequality, by providing income to those in need, fiscal policy could reduce economic inequality. In most if not all cases, expansionary fiscal policy would be expected to increase real GDP. One possible exception would be a case where expansionary fiscal policy leads to an equal decrease in spending elsewhere in the economy. Focusing just on government purchases, under complete crowding out, an increase in G would cause a reduction in consumption, investment in physical capital, and/or net exports such that real GDP, the sum of C, I, G, and NX, does not change. Such a case, called complete crowding out, seems very unlikely particularly in light of the millions of people in the U.S. who are unemployed. In the absence of complete crowding out, we would expect that expansionary fiscal policy would increase real GDP, at least in the short term, in the domestic economy.
Those concerned about the cost of additional expansionary fiscal policy should be aware of an insight of modern money theory, also called modern monetary theory. Although it may possibly have not originated in modern money theory, one of the key points of modern money theory, at least as discussed by Wray (2015, 2nd edition, p. 199) in Modern Money Theory (short title) is that a currency-issuing government can afford anything in that economy if that money is not tied directly to another currency or a commodity. Clearly, this does not necessarily mean that a government can afford everything, but it seems reasonable to think that the U.S. could be doing more. While state and local governments in the U.S. may be more constrained budget-wise because they do not issue their own currencies, the federal government does not face such a constraint.
Additionally, those concerned about the cost of budget deficits that go with expansionary fiscal policy may also consider another insight of modern money theory. Government budget deficits mean that either the domestic sector or the international sector is (or both are) running a budget surplus with the domestic government. Thus, the borrowing associated with deficit spending leads to financial wealth for either the domestic private sector or the international sector or both. Therefore, the federal budget deficits could create wealth for the domestic private sector. For more and some possible caveats and qualifiers, readers can refer to Wray (2015, 2nd edition, sections 1.1 and 1.2, for example).
Letting G fall in the U.S. implies taking a useful tool away from policymakers at a time when the economy could use expansionary fiscal policy in an effort to complete the recovery from the COVID-19 recession (and by at least two measures the Great Recession). To this point, the fiscal and monetary policies implemented have not been enough to return real GDP back to where it was in the fourth quarter of 2019. What more could be done to increase government purchases? Also, what more could be done in terms of increasing government transfer payments and reducing taxes to provide additional disposable income to those who would likely spend a large portion of their newfound disposable income quickly after they receive it? Although monetary policy should probably continue to be expansionary, should it be in a supporting role to allow fiscal policy to take the lead? Hopefully, stimulus checks will be coming again soon.
Subsequent data revisions may change the above analysis. The following websites were helpful in preparing this blog entry.
https://www.bea.gov/sites/default/files/2021-01/gdp4q20_adv.pdf
(Table 1 and Table 3 from the above)
https://fred.stlouisfed.org/data/M1SL.txt
https://fred.stlouisfed.org/data/GDPC1.txt
