Economics: A Fiscal Puzzle

While Fitch’s downgrade drew attention to the US fiscal position, the widening of the budget deficit over the last year matters more from a macro perspective. Some have argued that this helps explain the economy’s resilience to tighter monetary policy.

As the Chart shows, it’s unusual to see the deficit widen like this while unemployment remains low. Of course, there’s the possibility that a larger deficit has indirectly supported growth, but the clearest link between fiscal policy and growth is in the CHIPS and IRA-induced surge in manufacturing construction investment.

According to the flow-of-funds identity, a wider fiscal deficit and narrower current-account deficit implies a rising private-sector surplus. Yet the data shows few signs of this: something doesn’t add up. Part of the answer lies in a growing ‘statistical discrepancy’ – which could ultimately see GDP get downwardly revised.