The stronger than expected US GDP data for Q2 contradicts the claims of both hardline monetarists and extreme Keynesians.
Although part of the Q2 strength reflects revised down growth for Q1, the latest report was still strong enough to boost the dollar.
But the results are especially impressive given the scale of the fiscal adjustment in the quarter. The Budget deficit in Q2 2012 was $125 billion. For Q2 2013 there was a surplus (!) of $91 billion. The scale of the fiscal adjustment over the period was actually 5.1% of quarterly GDP which is huge and dwarfs anything done in a single year in the UK.
Extreme monetarists who claim that a fiscal deficit can be reduced without any impact on GDP are contradicted by the slow growth which is heavily influenced by the fiscal contraction.
But even more so, extreme Keynesians are contradicted by the fact that the US can cut more than 5% from its fiscal deficit and still continue growing – if slowly. Having said that, the squeeze has not only been more than intended but also more than necessary.
When we were in Washington DC earlier this week we met various people who were being affected by the impact of the sequester on government spending, including officials on ‘furlough’ who were banned from going into their offices because they were not being paid and defence contractors whose orderbooks had dried up.
Because most of the necessary fiscal contraction in the US has already been carried out as a result of the greater than expected fiscal squeeze in response to the sequester, it is likely that there will be some relaxation in budget cutting in the coming quarters. So we expect growth to accelerate. If this happens, then there is a good chance that QE will have to be pared down early next year. But the conventional wisdom until recently that the QE would be phased down in September seems premature.
Douglas McWilliams, Cebr Chairman
For previous updates in Doug’s US travel series, please see below: