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In Advance Of The GDP Report, Goldman's Hatzius Sees 3% GDP Drag From State, Local And Federal In Coming Year

Tyler Durden's picture




 

Tomorrow's GDP report will be a major market catalyst as it will either confirm that an inflationary double dip has now arrived and the Fed will have no option but to print, or it will come "just better than expectations", once again sending the market into a lithium-deprived paroxysm of intraday jerkiness. Yet in the medium run, tomorrow's number is very much irrelevant, especially if Jan Hatzius' latest analysis on the impact of various trends at the local, state and federal level turns out to be correct. Goldman's analysis is based on the following assumptions: (1) Congress will not extend emergency unemployment benefits beyond the current expiration date in November 2010, (2) state governments will need to make do without any additional federal fiscal aid beyond what was included in ARRA, and (3) Congress extends the lower- and middle-income tax cuts of 2001-2003 as well as the Making Work Pay tax cut of 2009 but not the higher-income cuts of 2001-2003. The latter is of particular significance because as Bloomberg reports, Obama is about to take populism into high gear, as Geithner will next week bring the proposed tax cuts for the rich directly to the masses (and the corrupt simians in the Senate). Obviously the financial implications of that one move alone will be disastrous and even if tomorrow's GDP number prove better than expected, the market may ultimately trade off on the devastating impact from the expiration of the most important subset of tax cuts. Which is why, going back to Hatzius, the Goldman economist states: "The overall impact of fiscal policy (combining all levels of government) is likely to go from an average of +1.3 percentage points between early 2009 and early 2010 to -1.7 percentage points in 2011, a swing of about -3 percentage points. We estimate that the boost to the level of GDP starts to decline in mid-2010, first gently and then more forcefully, setting up a significant negative impact on GDP growth in late 2010 and 2011." The only thing Hatzius forgot to add is brace yourselves for impact. Yet somehow Goldman's own David Kostin projects that 2011 S&P EPS will grow by double digits... even as the firm's own economic team anticipates an economic crunch. This is precisely the conflicted double speak that we have grown to love and expect from the Wall Street sellside.

Full Goldman note below:

Today’s comment integrates state and local finances into our analysis of the impact of fiscal policy on real GDP growth.  We include changes in spending and tax policy at the state and local level—as discussed in last Wednesday’s daily comment—directly in our analysis, instead of the transfer payments from the federal government to state governments in the American Recovery and Reinvestment Act of 2010 (ARRA).  We believe that this results in a more complete and realistic assessment of the overall stance of fiscal policy at all levels of government.

These estimates imply that the overall impact of fiscal policy (combining all levels of government) is likely to go from an average of +1.3 percentage points between early 2009 and early 2010 to -1.7 percentage points in 2011, a swing of about -3 percentage points.  The main difference compared with our federal-only estimates is a smaller positive impact of overall fiscal policy in 2009 as well as a somewhat earlier weakening in 2010.  The reason is that state and local policies have exerted a drag on growth all along, and this drag has increased somewhat in early 2010.

Most analyses of the impact of fiscal policy on GDP growth—those of the Congressional Budget Office (CBO), the Council of Economic Advisers (CEA), and numerous private-sector forecasters including ourselves—have focused on the role of federal fiscal policy.  More precisely, they have estimated the impact of the American Recovery and Reinvestment Act of 2009 (ARRA) on GDP relative to what would have happened to GDP in the absence of ARRA.

In general, these estimates are fairly close to one another.  The CEA’s latest quarterly update summarizes three official and five private-sector estimates of the cumulative impact of ARRA on the level of GDP as of mid-2010, which are clustered in a reasonably tight range from 2.2% to 3.7%.  (See Table 8 of the following report: http://www.whitehouse.gov/files/documents/cea_4th_arra_report.pdf; the preceding statement is based on the midpoint of the CBO’s “low” and “high” estimate.)  Our own estimate of the impact is 2.6%, i.e. modestly below but fairly close to the midpoint of these estimates.  Moreover, we estimate that the boost to the level of GDP starts to decline in mid-2010, first gently and then more forcefully, setting up a significant negative impact on GDP growth in late 2010 and 2011.

But while the impact of ARRA on GDP is an important question from both an economic and political perspective, it is not necessarily the best guide to the overall impact of fiscal policy on GDP growth, for at least three reasons.

First, there have been several “follow-on” fiscal programs since the enactment of ARRA, including the “cash for clunkers” program, the homebuyer tax credit, and repeated extensions of unemployment benefits. These need to be taken into account as well in gauging the impact of fiscal policy.  (We have been doing this in our fiscal policy analysis already.)

Second, the potential expiration of the 2001-2003 tax cuts has received increasing attention in recent months (see Alec Phillips, “Extending the Expiring Tax Cuts: What, How, When, and Why,” US Daily, July 26, 2010).  This also needs to be taken into account in a gauging the impact of fiscal policy.  (We have been doing this as well.)

Third, although the analysis of the GDP boost from ARRA includes a line item for aid to state governments, this does not appropriately capture the impulse from state and local governments.  In calendar 2009, ARRA provided about $60 billion of funding for state governments, which is equivalent to 0.4% of GDP.  Including multiplier effects, this implies a boost to real GDP growth of around 0.5 percentage point in the standard ARRA-related calculation.  But despite the ARRA funds, state and local governments have exerted a significant drag on real GDP growth since 2009, as we showed last week. (See “The State and Local Drag Continues,” US Daily, July 21, 2010.)  This does not mean that the standard ARRA analysis is “wrong”—after all, if state governments hadn’t received funds from the federal government, they would have had to cut back even more.  But if we are interested in the overall fiscal impulse to GDP, we should look at the impact of state and local governments on the rest of the economy via their spending and tax policies, not at the impact of the federal government on state government finances.

The chart below provides an integrated look at the GDP growth impact of fiscal policy at the federal, state, and local level.   These numbers are based on our current assumptions that (1) Congress will not extend emergency unemployment benefits beyond the current expiration date in November 2010, (2) state governments will need to make do without any additional federal fiscal aid beyond what was included in ARRA, and (3) Congress extends the lower- and middle-income tax cuts of 2001-2003 as well as the Making Work Pay tax cut of 2009 but not the higher-income cuts of 2001-2003.

Two additional comments are in order.  First, we have lengthened and smoothed out the impact of tax changes on spending in order to reduce the volatility in quarterly GDP impulses from fluctuations in tax refunds and final settlements from one quarter to the next.  Second, we recognize that part of the impact from income replacement measures, most prominently emergency unemployment benefits, is not a completely “exogenous” consequence of a shift to more generous benefit provision in ARRA but also partly an “endogenous” consequence of weakness in the economy.

 

The upshot of the chart is that the overall fiscal impulse to GDP growth is likely to go from +1.3 percentage points between early 2009 and early 2010 to -1.7 percentage points in 2011.  There are two main differences compared with our federal-only estimates—(1) a smaller positive impact in 2009 and (2) a somewhat earlier turn into negative territory in 2010.  The reason for both is that state and local finances have been a drag on growth all along, and this drag has increased somewhat in early 2010.  The earlier turn toward restraint may be one reason why growth has been weakening noticeably over the past few months, although the end of the positive inventory cycle has undoubtedly also been an important factor.

However, the basic implication is unchanged from our prior analysis—namely that fiscal policy will result in a substantial “swing” from stimulus to restraint.  This is likely to contribute to slower GDP growth of around 1½% (annualized) in the second half of 2010, and it implies downside risks to our current forecast of 3% growth (on a Q4/Q4 basis) in 2011.

 

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Thu, 07/29/2010 - 18:15 | 495139 VK
VK's picture

Who needs Goldman when we can have real time data? The charts clearly show the economy is in a recession and that things are worsening! D'oh!!! Oh and I'm not long Chinese solars.

http://www.consumerindexes.com/index.html

? The amount of damage done to an economy by an economic slowdown can by quantified by multiplying the event's average rate of contraction times the duration of the event. By that measure the 2010 contraction has now inflicted 43% as much pain on the economy during its first 6 months as the 'Great Recession' did during the first 6 months of that slowdown.

? Although this contraction has not yet reached the extreme contraction rates that were seen during 2008, after 6 months it has not yet formed a bottom. Furthermore, it is now likely to last longer than the 2008 event.

? In an even broader perspective, the current level of the Daily Growth Index over the trailing 91-day 'quarter' would put it among the lowest 6% of all calendar quarters of GDP growth since 1947. Only roughly 1 in 17 quarters of GDP activity have been worse.

? The duration of the current contraction event is becoming a real problem. Our trailing 183-day 'two consecutive quarters' growth index has dropped into the 5th percentile among similar two consecutive quarters of GDP 'growth' since 1947. This means that the trailing 6 months have been statistically worse than the trailing 3 months -- less than one in twenty 6-month spans have been worse since the BEA began keeping quarterly records.

Thu, 07/29/2010 - 18:40 | 495171 thesapein
thesapein's picture

Seems like they're trying to avoid even the question of a double dip or depression and instead want to focus on a tightening of the belt (around our necks) and an austerity program that micro-focuses on the state and local level. That's my interpretation, and it ain't pretty, looking at Greece.

It's exactly what they did to Greece and why the Greeks hate GS more than we do.

Thu, 07/29/2010 - 18:54 | 495201 Thisson
Thisson's picture

Too bad, because austerity is exactly what we need.  We wouldn't have reached this point if y'all had just voted for Ross Perot when you had the chance.

Thu, 07/29/2010 - 19:06 | 495219 thesapein
thesapein's picture

I did vote for Perot!

I agree with you, totally.

But I'm also more open to local governments doing whatever those communities want, and going bust if they want. I'm more about downsizing on the national level. The federal government ought to swallow this medicine first and foremost.

Thu, 07/29/2010 - 22:19 | 495455 slobbermut
slobbermut's picture

The Piper has to be paid...for state and local communities, only BK can allow for the nullification/adjustment to retirement benefits, labor contracts, which will otherwise suck every last discretionary penny from taxpayers to the government.  All academic, as it is too late anyway.  Default is coming, only a matter of time.

Thu, 07/29/2010 - 18:32 | 495159 thesapein
thesapein's picture

ah, so they're planning a push for "austerity"

Thu, 07/29/2010 - 18:35 | 495166 nmewn
nmewn's picture

Them or us? ;-)

Thu, 07/29/2010 - 18:51 | 495196 thesapein
thesapein's picture

hah!

Seriously though, they specifically stated the culprit as being state and local governments. This gives me the impression that we'll see a continuation of layoffs for local and state law enforcement (except for those specially trained in Iraq as many are being sent overseas to train) and replacement by federal enforcers, including the military, who will be better equipped to handle riots, gun confiscation, setting up checkpoints, etc.

It all makes perfect sense and even sounds reasonable if you're a zombie.

Thu, 07/29/2010 - 19:06 | 495221 nmewn
nmewn's picture

"Seriously though, they specifically stated the culprit as being state and local governments.
Well, I think we all know of the many unfunded mandates that were passed down from on high.

You know, the ole if you don't do X your federal funding for Y will be cut and we'll make sure you, Governor Goldfarb, are held up as the one who stood against X causing Z to happen ...so X was done to balance the yearly Z state & local fiscal budget.

All this blackmailing ponzi crap is coming to an end. And I don't put much stock in the whole Mad Max routine. There have always been more of us than them.

Thu, 07/29/2010 - 18:52 | 495197 thesapein
thesapein's picture

double-post

Thu, 07/29/2010 - 18:36 | 495167 RobotTrader
RobotTrader's picture

It's the longest recession we've had in decades.

Bad data keeps coming out.  Sometimes the market sells off.  Sometimes it ignores it.

Bottom line is that we are still at 1,100 with some of the absolute worst economic headlines in a generation.

Eventually things will get better, and the market will start taking off in anticipation.

Fools like Jim Pupulava who are short and won't go long until they see the ECRI turn around will miss out on the first 150 point gain in the SPY...

So bears need to beware.

Just watch "The Squid", MS, and some of the banks.

No weakness yet.

And notice how the CRB has clearly broken out to the upside:

 

 

 

 

Thu, 07/29/2010 - 23:16 | 495514 AccreditedEYE
AccreditedEYE's picture

So bears need to beware.

Just watch "The Squid", MS, and some of the banks.

No weakness yet.

Robo, you're killing me bro. Economic data is ignored until it isn't. :) I hope that you have at least been making money on this move up....

Fri, 07/30/2010 - 05:45 | 495673 Kreditanstalt
Kreditanstalt's picture

Not true: this is a rolling top.

Forget technicians and charts...sentiment, which is what drives markets, is shaky at best, despondent at worst...just waiting for the first big fund or holder of dividend-payers to sidle ~ or flee ~ towards the exits. 

The only real money I've made this week has been SHORT...

Fri, 07/30/2010 - 06:52 | 495690 nmewn
nmewn's picture

Colgate & Kellogg yesterday? ;-)

Thu, 07/29/2010 - 18:38 | 495169 traderjoe
traderjoe's picture

Just wait to see what the GDP impact will be when we get a muni default. 

Thu, 07/29/2010 - 18:38 | 495170 buzzsaw99
buzzsaw99's picture

when the squid and cnbc start with the bear-talk it's time to buy.

Thu, 07/29/2010 - 18:51 | 495198 VK
VK's picture

The only time it pays off to be a 100pc bearish is when a ponzi scheme is falling apart.

Thu, 07/29/2010 - 18:55 | 495205 Thisson
Thisson's picture

Good thing that could never happen, right?  /sarcasm/

Thu, 07/29/2010 - 19:27 | 495252 buzzsaw99
buzzsaw99's picture

ponzi is our president.

Thu, 07/29/2010 - 23:13 | 495430 Village Idiot
Village Idiot's picture

"ponzi is our president."

 

New hit television show - Happy Days!

Starring - Barry Obama as "the Ponz"

 

Somebody take it from here...

 

Thu, 07/29/2010 - 19:18 | 495232 Rogerwilco
Rogerwilco's picture

"It's the longest recession we've had in decades."

IIRC, aren't they called depressions? Markets do funny stuff inside them and the true nature of the mess is typically recognized only at a later date. Subtract 12% from notional GDP and tell me how bullish you feel.

Thu, 07/29/2010 - 20:51 | 495349 All_In
All_In's picture

Question: At what point was the 1930's called The Great Depression?  Was it when it was actually happening or was it 5,10 or 20 years later after it had passed?  Because I would be willing to bet historians will call this period a depression as well some day...

Thu, 07/29/2010 - 21:01 | 495361 Navigator
Navigator's picture

Numerous reporters and analysts have been calling this the "Bush Depression" since at least 2007.  Google it if you don't want to believe.  Then tell us why the phrase "Bush Tax Cuts" has his name attached in all mainstream media while, at the same time, so much of the media is shy about placing the cause of this depression where it belongs by routinely using the phrase "Bush Depression".

Thu, 07/29/2010 - 21:28 | 495398 zen0
zen0's picture

I have seen the information but can't recall it right now. I was a few years in, at least before the term was used.

 

It is somewhere in The Return of the Great Depresson, by Vox Day , but I can't give you a page number.

Thu, 07/29/2010 - 21:30 | 495400 Rogerwilco
Rogerwilco's picture

@ All in

The markets recovered nicely after the 1929 crash, and Hoover pronounced that the economic troubles were behind us. Sounds familiar, doesn't it?

Thu, 07/29/2010 - 19:43 | 495279 Rainman
Rainman's picture

Squid analysts are now patronizing the palm readers weekly. Hookers and blow are so........2006.

Thu, 07/29/2010 - 21:22 | 495389 zen0
zen0's picture

Isn't the GDP a Chinese number and therefore irrelevant.?

Thu, 07/29/2010 - 21:38 | 495409 belogical
belogical's picture

Non of the economic numbers matter anymore because they are so inaccurate that they always get revised and just about never in a good way

Thu, 07/29/2010 - 23:51 | 495544 miaent
miaent's picture

ZH, You should support differing opinions from the same firm's research team.  This is good... 

Fri, 07/30/2010 - 00:59 | 495584 pamriallc
pamriallc's picture

goldman knows that this will never happen but they have to give the "world" the "what if?" scenario.  in the real world the FED will do what is necessary to give *the people* what they like to see from a *humanistic side* of investing in anything--  people love rising prices even if overall inflation is rising faster.  we will receive *nominal* returns which are "positive" over time and while taxes and etc. will drag on growth this is not new news.  frankly, the *inflation* that they are currently and desparately trying to create is in fact the goal in the long term.  the FED has never been unsuccessful in this effort, nor will it ever be unsuccessful in creating inflation.  in the end, "common folks" will take "rising prices" of anything in exchange for falling prices where their "personal assets" are concerned.  inflation-adjusted *real* growth is not going to happen, but NOMINAL growth via-inflation is a long term guarantee.  the FED has the power to create as much "nominal" GDP "growth" as it wants to create, and congress and the senate will decide how to spend the money that's printed.  it is the way of the world, and it will continue to happen as it has for literally 2000 years.  goldman is acting as though stimulus will not continue and frankly--- the piece is politically motivated as it clearly encourages the continuation of Bush-era tax cuts which are good for their clients.  a good piece of work, actually, but nominal growth will happen either way.  shawn mesaros, pamria, llc 

Fri, 07/30/2010 - 09:34 | 495891 vxpatel
vxpatel's picture

It's INFLATION - b/c the economy always has to go grow....and other fairy tales.
Deflation would seem to be the prevailing trend in my neighborhood, Beverly Hills CA. Lots of office space for lease/sale, lots of houses suddenly on the market and used Range Rovers for 10's of thousands less than a few years ago... 

What if the fed printed a bunch of money and no one actually wanted anything new...b/c suddenly they didn't even want the stuff they already had, which they couldn't afford in the first place...which is why they took out the 2nd mortgage on their house (b/c housing prices always go up) 

Suddenly things like extra cars, elective plastic surgery (@#$%&! especially), giant SUVs, extra houses, meals out...etc etc etc suddenly become less appetizing. 

deflation...could be much more serious than inflation, and this is the first time in my life i've ever hear the word tossed about, like that other serious word...austerity.

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