US Economic Forecast Q3 2022

Government policy

The large fiscal impulse from COVID-related spending has largely been reversed. The government’s contribution to GDP has been negative over the past three quarters, creating some fiscal drag. This weakens demand and is one of the reasons why the baseline forecast calls for inflation to moderate by 2023. Essentially, the federal government is adopting a restrictive policy which should dampen demand, while in the at the same time, the Fed raises interest rates. It takes time for fiscal and monetary policy to affect demand. The danger is that both types of policies have become too restrictive, and when the full impact of both is felt, the economy is expected to slow too much. (Recent spending bills won’t have an immediate impact on spending, though they will help support federal spending over the five-year forecast horizon.)

The new Inflation Reduction Act is likely to have only a modest impact on inflation. Despite its name, the main impact of the bill will be felt years from now, not the inflation figures for the next few months. The main impact of the bill will likely be through the energy and climate change provisions, and these take years to have an impact. Tax provisions, while very important to some taxpayers, are not likely to alter overall tax collections or investment incentives to such an extent. And many people who buy health insurance through the Affordable Care Act exchanges will be helped by the extension of medical insurance subsidies. But the overall impact on the deficit is expected to be modest. The Congressional Budget Office score showed a net decrease of US$90 billion over 10 years. In the context of a federal budget with nearly $7 trillion in spending this year, $9 billion in one year, that’s just not a lot of money.

The infrastructure spending bill, already in place, will increase government spending over the next 10 years. This spending will increase the capacity of the economy and will likely help stimulate further productivity growth. However, much of this additional spending comes towards the end of our forecast horizon. The total spending impulse will be moderated by higher inflation. And the amount of spending is relatively modest compared to the economy as a whole. According to the Congressional Budget Office, in 2026, the peak spending year, the bill will add about $61 billion to the federal deficit.8 This represents about 0.2% of projected GDP. The infrastructure bill is likely to have a positive and significant impact on public capital in the United States, but it is by no means a major fiscal stimulus.

Meanwhile, Congress and fiscal policy are getting tougher. Congress finally passed an appropriations bill, in late May, for fiscal year 2022. The next fiscal year begins in October, so the fall will see what has now become a normal state of US government budgeting – ongoing resolutions and uncertainty that linger well into the fiscal year.

Our baseline forecast assumes that deficits will fall by 2022 to less than US$1.4 trillion per year and then rise slowly. This is a considerable amount, which inevitably raises the question of whether the US government can continue to borrow at such a rate. The answer is that it is possible, until investors lose confidence. At this point, most investors show no signs of concern about US debt. In fact, very low interest rates on US government debt indicate that the world wants more, not less, US debt. We do not foresee any issues over the forecast horizon.

But the government will face a crisis if it does not eventually find ways to reduce the deficit and the borrowing that results from it. The crisis may be many years away and current conditions argue in favor of waiting. It might, however, be a bad idea to wait too long once these conditions have been lifted.