Expectations for Less Government Spending This Year Are Probably Wrong (February 24, 2024)

Economic cracks and rising federal interest expense are two reasons to bet on more fiscal spending and Fed intervention, not less 

By Lisa Beilfuss

The so-called fiscal impulse–whether government fiscal policy decisions are adding to or subtracting from demand in the economy–is broadly assumed to be negative this year. That might not wind up to be true.

A set of announcements in the latest week highlight ongoing government interventions that amount to new stimulus. The Biden administration wiped an additional $1.2 billion in student debt, bringing the sum to about $138 billion. At the same time, the Federal Housing Administration unveiled a new program for delinquent borrowers with FHA-insured mortgages that can temporarily reduce a monthly payment by up to 25%. The agency meanwhile extended pandemic-era aid programs, which were on track to expire in October 2024, though April 2025. 

The latest fiscal efforts, however, shouldn’t be fully ascribed to election-year politics, where the opposing party is a natural counterforce. Consider data from real-estate data provider ATTOM, which show that U.S. properties with foreclosure filings in January rose 5% from a year ago and 10% from the prior month. The point is Wall Street’s broad expectation for fiscal spending to decline in 2024 from 2023 may reflect an underappreciation of weakness under the surface and the government’s desire and ability to support the U.S. economy. 

While no one doubts fiscal spending will remain relatively high for the foreseeable future, it is the change that matters for GDP math. The U.S. deficit roughly doubled in 2023 to 6.2% of GDP, marking the biggest non-recessionary deficit on record. While the full extent of that expansion isn’t considered stimulus in a classic sense, it is clear the federal government took in a lot less cash than it sent out, says Ginger Chambless, head of research at J.P. Morgan’s commercial banking unit. She expects the deficit to remain high relative to GDP, but estimates a narrowing to 5.9%. 

The swing in fiscal spending in 2023 as compared to 2022 boosted inflation-adjusted GDP by 3 percentage points in last year, representing nearly all of 2023’s growth, notes Piper Sandler chief global economist Nancy Lazar.  She expects a fiscal drag of 0.7 percentage point this year, but she warns that risks are to the upside. 

If the tax-cut proposal advanced by Senator Ron Wyden and Representative Jason Smith should become law, and payouts from the pandemic Employment Retention Credit program occur, Lazar estimates a combined $256 billion in fiscal support from those two programs alone. That would add nearly a full point to this year’s GDP, potentially enough to stave off recession, and save roughly 1.5 million jobs to cap this cycle’s unemployment rate at 4.5%. 

All of this isn’t to mention the basic but crucial idea that relatively tight monetary policy itself is exacerbating loose fiscal policy. 

With federal debt now 120% of GDP, Fed rate hikes increase the federal interest expense–and thus overall fiscal deficit–at a faster rate than it slows bank lending and corporate bond issuance, says Lyn Alden, founder of Lyn Alden Investment Strategy. The Congressional Budget Office earlier this month said the U.S. government is on track to spend a larger share of economic output on annual interest payments than at any other point in history.

“The Fed’s control loop is less effective in high public-debt environments than it is in low public-debt environments, and beyond a certain point can even be counter-effective,” Alden says. “Their tools don’t address the fiscal side, and in some cases they can even contribute to a federal debt interest spiral, where more debt needs to be issued to fund larger interest expense, which in turn further increases the interest expense and requires more debt issuance.” Interest earners can meanwhile spend that income into the economy, while large deficits threaten Treasury-market liquidity to potentially force Fed intervention, she adds.

It is worth taking a step back. Several years ago, David Rosenberg, economist and founder of Rosenberg Research, told this writer that a debt jubilee in the U.S.--large scale debt forgiveness–is inevitable. Praxis caught up with Rosenberg over the last week. His thoughts throw cold water on Wall Street’s expectation of a negative fiscal impulse.

Here is how Rosenberg lays it out. The U.S. had a year of full employment, and yet the fiscal deficit grew about 25%. Normally when nominal GDP growth is running at about 6%, like in 2023, the government gets an 8% tax-revenue stream out of it and the deficit dramatically falls. But tax revenue dropped 7% last year. 

“How could the deficit balloon like that with sub-4% unemployment and 6% nominal growth? It’s because of the subsidies. Subsidies layered on subsidies,” says Rosenberg, referencing the CHIPS Act and the Inflation Reduction Act as examples. Illustrating his point: Huge sums from the government have produced a boom in construction spending while industrial production has held basically flat. 

What this amounts to is “jubilee light,” Rosenberg says, started during the pandemic and different from a full jubilee in that there isn’t direct debt monetization. Instead, massive fiscal spending has been financed through the secondary market as the Treasury sells debt into the private market and the Fed buys bonds off of banks’ balance sheets. 

“So much tape and glue has been put on this house of straw that it’s hard to imagine the economy without all this support,” says Rosenberg, adding that economists and investors have no idea what financial assets would look like if the the fiscal deficit and the Fed’s balance sheet ever normalized to pre-2009 levels. 

It may not matter. “The Fed has laid its cards on the table. It doesn't matter if you're on the left or the right,” says Rosenberg, describing how a bloated central bank balance sheet has in 15 years gone from a controversial policy tool to simply part of the landscape. While the current focus is on higher-for-longer interest rates, the bigger picture is that quantitative easing will remain increasingly more aggressive. 

“If they went so far as the high-yield market, maybe they’ll be buying up office space,” Rosenberg says, referring to the Fed in 2020 expanding its emergency bond buying to junk bonds and referencing brewing trouble in the commercial real estate market.

Depending on how one looks at it, expectations for a negative fiscal impulse this year may be overly optimistic. A positive surprise may be the difference between GDP numbers that reflect ongoing growth and numbers that suggest recession. It may also make it increasingly clear that the reality under the surface is precarious, with the U.S. economy requiring evermore support.