The past four years have seen a level of US government spending and debt unmatched outside of World War Two. The early 1980s period is the only contender. From 2009-2012, spending as a share of output averaged 24.4%. During that same period, annual budget deficits averaged 9.1% of GDP. From 1982-1985, federal spending averaged 22.9% of output, annual budget deficits 4.9%.
Yet despite all that spending and debt, the US has actually been experiencing a period of sharp fiscal consolidation since the end of the Great Recession (reflected in the above chart). Economist Mike Darda of MKM Partners:
Despite a widely held view to the contrary, there has been a passive fiscal tightening under way for three years in the U.S. Although the federal spending/GDP ratio exploded during the recession, it peaked near the business cycle trough in mid-2009 and began to recede in 2010. There has been no net growth in total federal expenditures since mid-2010. As a result, the U.S. fiscal deficit has fallen to about 6.5% of GDP from a peak of 10.4% in late 2009.
Now how has the private-sector economy been faring during this period of government retrenchment? Not bad, all else equal. Nominal private-sector GDP has risen by 5% each of the past two years. Of course, the “all else equal” ignores the need for some catch-up years of higher-than-average growth to close the output gap. But that will require some pro-growth tax and regulatory policies not on Washington’s agenda right now.
As it happens, JPMorgan just revised its 2013 GDP forecast to 1.9% from 2.1% based on the political assumption that most of the budget sequester happens. But that minor downgrade is really due mostly to a cut in government’s contribution to GDP. What we are seeing is a slow reformulation of GDP, less government, more business. That’s a good thing — and the sequester will accelerate that transition.