Input Shocks, GDP, Multipliers, And QE

by: Ironman at Political Calculations

In the latter part of 2012, the United States' economy was falling into recession. We know this because we watched in real time as the forces of recession built up through much of the second half of 2012, as a surprising number of U.S. companies were acting to cut their dividends. That observation has since been confirmed by the S&P 500's earnings data, which reveals that much of the private sector of the U.S. economy was indeed experiencing at least an earnings recession in the last six months of 2012, as the level of earnings earned by U.S. businesses dropped below their previously recorded values.

Worse, following his re-election, the nation's president was also committed to doing the stupidest thing that a nation falling into recession can possibly do: Hike the taxes of its most productive citizens. That situation was like an oncoming train wreck that no serious observer could help but notice was about to happen. Even from the corner of 20th Street and Constitution Avenue in Washington, D.C. -- the headquarters of the U.S. Federal Reserve.

On Dec. 12, 2012, the Federal Reserve did what it does best these days. It cranked up its quantitative easing policy machine to do whatever it could to compensate for the poorly-considered fiscal policy propagating from 1600 Pennsylvania Avenue in Washington, D.C. At that time, the Fed committed to boost its net purchases of U.S. Treasuries by $45 billion per month, on top of its monthly net purchases of $40 billion worth of mortgage-backed securities that had previously established on Sept. 13, 2012, to fuel the growing fire within a U.S. housing sector that had recently gained traction.

So what happens to GDP when the Fed is adding a net $340 billion per quarter to the U.S. economy? At the same time the U.S. government reduces its spending by a small amount from inflated levels as it really cranking up its taxes? The answer may be found in our tool below, where we've combined the indicated factors for the first quarter of 2013 along with the fiscal policy multipliers that have been determined for how each affects GDP in the U.S., to determine how each affected the nation's GDP in the first quarter of 2013.

Click to enlarge images.

*If unemployment rate is ≥ 7.5%. Multiplier is 0.5 if unemployment rate is < 7.5%.

Click here to access a working version of this tool.

Through the U.S. Bureau of Economic Analysis' second estimate of GDP for the first quarter of 2013, the U.S.' nominal GDP is presently estimated to be $16,004.5 billion, just $15.1 billion, or 0.09%, off from what our fiscal multiplier analysis suggests it would be for the values we've entered in our tool above. Looking at the individual effects on GDP, we see that the tax increases were by far the biggest drag on economic growth in the quarter, with government spending cuts having a much less than a dollar-to-dollar impact.

But we find that the Fed's changes to its monetary policies would appear to have been more than sufficient to make up for the effects of these fiscal policies. That difference is what appears to have given the U.S. such a different outcome that Spain experienced in 2012, where that nation saw no similar monetary policy that might have counteracted the negative effects of its destructive tax hikes upon its economy.

More About the Numbers in the Tool

GDP and Government Spending: The GDP ($15,864.1 billion) for the previous quarter (Q4 2012) was taken from the BEA's second estimate of GDP for Q1 2013 ($16,004.5 billion), as was the number we entered for the change in government spending from the previous quarter (-$26.0 billion). We should note that $20.0 billion of this reduction in government spending occurred at the federal government level, with the balance being recorded for state and local governments.

2013's Tax Hikes

The total for the change in the amount of taxes in the U.S. is based on the fiscal cliff tax deal of Jan. 3, 2013, which increased the Social Security payroll tax by 2%, as well as increased the tax rates paid by high income earners and also the tax rates for investments.

Social Security Payroll Tax Hike: Here, we estimated the additional amount that President Obama expects to collect through Social Security's combined employer/employee payroll tax of 12.4% in 2013 (as indicated by Table 2.4 of President Obama's FY 2014 budget proposal) compared to what would have been collected under 2012's combined tax rate of 10.4%. We arrived at a figure of $108.6 billion for the year, for which we assumed that one-fourth ($27.16 billion) would be collected in the first quarter of 2013.

Obamacare Taxes: We also took into account the tax increases that went into effect on investment income and on high-income earners as part of the Patient Protection and Affordable Care Act, which are expected to total $36 billion in 2013, one-fourth ($9 billion) of which we assumed was incurred in the first quarter.

Fiscal Cliff Income and Investment Tax Hikes: The remaining portion of tax increases taking effect were a direct outcome of the increases in the top income tax rates and on investment income mandated as part of the fiscal cliff tax deal at the beginning of 2013, where a static analysis indicates that the $80.6 billion more in taxes will be collected in 2013, one-fourth ($20.15 billion) of which might be applied to the first quarter of the year. Combined, these values total up to a tax bill for Americans that's $225.2 billion higher for Americans in 2013 than in 2012, which works out to be approximately $56.3 billion higher for just Q1 2013.

About the Multipliers

We featured a discussion of the fiscal multipliers for government spending and tax policies in our previous discussion of Spain's disastrous economic choices of 2012. We're simply assuming that the fiscal multiplier for the Fed's quantitative easing programs is 1.0. However, in playing with the tool above, we found that a multiplier of 0.955 would be sufficient to make the results match the currently known outcome for the United States' GDP in Q1 2013.

That agrees with other evidence that indicates that the multiplier for the Fed's monetary policies has dropped below a value of 1.0 with the onset of its zero interest rate policy (ZIRP) during the previous recession. We should note that even with this lower multiplier value, it would appear that monetary policy can easily offset any negative effects from government spending cuts because the GDP multiplier for government spending is considerably lower.

The same cannot be said for tax hikes, where an outsized increase in the amount of the central bank's purchases of Treasuries and other bonds and assets would be needed to compensate for the destructive nature of tax increases on economic activity.