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Tag: Fiscal Austerity

Further fiscal drag poses risks to the US economy – Sober Look

One of the reasons for the slow US recovery has been weaker than usual government spending. The weakness started with fiscal consolidation at the state and local level, driven by sharp declines in tax revenues. The negative impact on the economy is now more pronounced at the federal level. In previous recoveries government expenditures provided cushion to the economy, while in this recovery the net impact of government activity creates a drag. Of course the recent tax increases have not been helpful either.

Source: DB

The most direct impact is visible in the number of government jobs – the impact on the private sector that services the government is of course quite large as well. The chart below shows the decline in government payrolls over time (not seasonally adjusted).

Source: US Department of Labor

While government payrolls continue to fall, the decline has been slowing – mostly due to the stabilization in state and local employment. Federal jobs however are another story.

Given the fiscal drag resulting from an already weak (relatively) federal spending, the US economy is highly vulnerable to a negative outcome of the upcoming debt ceiling/budget fight. And while tightening federal spending is absolutely vital, a disruption at this juncture could prove to be costly.

BNY Mellon: – The upcoming showdown between Republicans and Democrats of Capitol Hill over both the 2014 federal budget and the national debt ceiling is shaping up to be a battle royal in Washington…”

In fact the “showdown” has already started. Some Republicans have threatened to shut down the federal government (by withholding funding) if the administration does not compromise on the Affordable Care Act. Yesterday the Obama administration fired back (see video below). While nobody thinks the situation will turn as ugly as it did in 2011, a major budget disruption (beyond the sequester) could create a serious setback for the US economy. And in this tepid recovery there is little else that could cushion this potential increase in “fiscal drag”.

What’s particularly concerning however is that after having developed a “tolerance” to repeated budget fights, the public seems to have completely lost interest in the topic.

Google Trends for phrase “federal budget” (US-based searches only)

Enjoy!

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IMF points to major risks in Portugal’s path to recovery- Sober Look

As the IMF approved its latest tranche of bailout funds for Portugal last week, the organization pointed out significant risks to the nation’s economy and its deficit reduction targets.

The IMF (report attached): – The solid social and political consensus that to date has buttressed strong program implementation has weakened significantly. Economic recovery is also proving elusive. And with the program bereft of tools to boost competitiveness in the near-term, there is a high risk that adjustment will continue to take place through more demand compression with too little compensating expenditure switching due to higher exports—particularly in light of still difficult euro area economic environment.

For a while it looked as though Portugal could potentially export its way out of the mess it was in. But those hopes have been dashed recently, as the nation’s net trade balance growth has stalled. What happened? Slow global demand softened growth in exports. At the same time, domestic demand, stung by austerity measures, keeps declining at 6-8% annually.

Source: Barclays Capital

With the risk of a sharper slowdown elevated, the IMF focused on four stress tests that were applied to Portugal’s debt to GDP projection: growth shock, rate spike, decline in potential (as opposed to actual) GDP growth, and contingent liabilities.  Here they are.

The IMF: –

1.  A growth shock that lowers the output by cumulative 5 percentage points in 2013 – 15 would raise the debt peak by 7 points to 131½ percent of GDP.

2.  An interest rate spike of 400 bps on all debt in 2013 – 15 would not have a large immediate effect, but it would slow down the rate of debt decline in the medium term, so that by 2020 the debt-to-GDP ratio is 5 points higher compared with the baseline.

3. A reduction in potential growth (from two to one percent in real terms) will have an impact that is numerically similar to the impact of an interest rate spike noted above.

4.  Realization of contingent liabilities (15 percent of GDP…) would immediately push debt close to 140 percent of GDP; debt would fall below 120 percent of GDP only in 2023 [this includes the 9 percent of GDP in debt of the SOEs that are classified outside the general government – see post on the topic]

And here is what the results look like. The combination of these factors looks particularly ominous with government debt to GDP growing to 150%.

Source: IMF

The risk of Portugal running into at least some of these headwinds – which would result in potentially higher/longer bailout requirements – remains elevated. The IMF has already loosened some fiscal consolidation targets for Portugal, but given the uncertainties involved, many economists remain skeptical.

WSJ: – The fund Wednesday approved a loosening of the country’s deficit-reduction targets, giving Lisbon more time to tighten the country’s budget.

Portugal’s economy is struggling with imposed austerity—including tax increases, wage cuts and cuts in the health and education sectors—and healthy growth is nowhere in sight. Output is expected to shrink 2.3% this year after a 3.2% contraction in 2012, while unemployment is close to 18%.

The fund said it can’t say with high probability that Portugal’s debt is sustainable over the long term, and noted the country’s finances are vulnerable to potential distress such as a deteriorating growth outlook and higher borrowing rates.

IMF Portugal Report

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