The next two years of unified Republican control of Congress are expected to see fiscal policy easing and boosting economic growth, in a reversal of the pattern that has held since the rise of the Tea Party.
Government and Wall Street economists believe that for the first time since Democrats ceded control of the House of Representatives to the GOP in 2010, government spending will cease being a drag on output growth and possibly even start aiding the recovery.
Following the bitter legislative battles that led to the “fiscal cliff” tax increases, the sequester spending cuts and the most recent spending deal brokered by Rep. Paul Ryan, R-Wis., and Sen. Patty Murray, D-Wash., the political outlook is for steady fiscal policy. There are no big tax hikes or spending reductions are on the horizon, said the Brookings Institution’s David Wessel.
“Nothing’s baked into the cake, nor does it seem likely that something’s about to happen,” said Wessel, a long-time economic policy journalist who now directs the think tank’s Hutchins Center on Fiscal & Monetary Policy.
The Hutchins Center maintains a “fiscal barometer” that measures the impact of fiscal policy on growth of the gross domestic product.
Following Tuesday’s GDP report that showed an unexpected increase in federal defense spending, the barometer showed fiscal policy adding 0.5 percentage points to GDP.
That is the first positive reading since the GOP took over the House in 2011 and reversed the Democrats’ stimulus efforts, setting aside a brief episode in 2012 in which the barometer was just barely positive.
This time, economists don’t see any looming political showdowns or other events that could prevent fiscal policy from boosting growth for the foreseeable future.
“After imposing a substantial drag on growth in 2013, the effect of federal fiscal policy on growth looks roughly neutral over 2014 and our current expectation is that it should remain roughly neutral in 2015 as well,” Goldman Sachs economists wrote in a recent research note.
Speaking in Abu Dhabi earlier in the month, Federal Reserve Bank of New York President William Dudley predicted that “fiscal restraint … is likely to disappear altogether next year.”
That is a view shared by other members of the Federal Reserve’s monetary policy committee. In its most recent policy statement in late October, the committee omitted a warning that fiscal policy was “restraining economic growth.” The Fed had included such a warning in its communications since the across-the-board sequester spending cuts were established in March 2013.
Even greater than the impact of easing federal fiscal policy, however, might be growing state and local payrolls.
States and cities hemorrhaged employees throughout the recession, as governors and mayors balanced their budgets by laying off teachers, police and administrators by the million.
But local employment bottomed out at just over 14 million in March 2013, and state payrolls followed soon after in July, at roughly 5 million.
This year, governments have begun slowly reversing some of those cuts, adding 85,000 jobs at the state and local level. The trend is expected to continue as tax collections and budgets improve with the labor market.
With Tuesday’s upward revision of third-quarter GDP to a 3.9 percent annual rate, adjusted for inflation and seasonal variation, 2014 growth is on track to eclipse 2013’s 2.2 percent. Then, the Fed expects growth to pick up in 2015 to 2.6 percent to 3 percent, with fiscal policy providing a “tailwind” boosting growth.
But that acceleration would likely come too late to reverse the political fortunes of the Democratic Party. Voters have long been deeply skeptical of President Obama’s handling of economic issues.
Ray Fair, a Yale economist known for a model of elections based on economic fundamentals, found pretty tough news for Democrats in his update following the midterm elections. Even with stronger economic growth in the next two years, Democrats are not favored to hold the presidency after Obama leaves.
“The presidential forecast thus suggests that even with a fairly robust economy the Democrats are not favorites,” Fair wrote.
