economy Markets

‘It’s The Private Sector, Stupid’: Trump May Have A Ricardian Equivalence Problem

One wonders if legendary "economists" Stephen Moore and Larry Kudlow anticipated this.

Conventional wisdom has it that incumbents will pursue expansionary fiscal policy in the lead up to an election.

If it really is “the economy, stupid“, then it would be political suicide not to pull out all the stops ahead of the vote.

Indeed, a look back at nearly four decades of history shows that in two elections when the incumbent was defeated, the fiscal impulse was neutral in the fiscal year immediately before the election and contractionary (i.e., the change in the structural deficit was positive) the year before that.

(Deutsche Bank)

As Deutsche Bank’s Stuart Sparks writes in a new note, “it turns out that the private sector was increasing savings (i.e. decreasing spending and/or investment) in the quarters before the election in both 1980 and 1992”.

Hold that thought.

Note in the table that in both the 1996 and 2012 elections, the incumbent (Clinton and Obama, respectively) held the White House despite a contractionary fiscal impulse in the year just prior to the vote.

Is that anomalous? Not really – or at least not when considered in context.

As Deutsche’s Sparks goes on to write, “the successful re-election campaigns of President Clinton and President Obama look somewhat less exceptional in light of the concurrent behavior of the non-financial private sector in addition to the behavior of the federal government”. Have a look at the following two charts:

(Deutsche Bank)

In a nutshell, those visuals show that the household sector offset (and then some) federal belt-tightening in the lead up to the 1996 election, while in 2012, the private sector as a whole engaged in aggressive belt-loosening.

Sparks provides a bit more color on both periods.

On Q4 1995 to Q3 1996:

While the non-financial corporate sector was modestly tightening its belt during much of the period, a big marginal decrease in net savings in Q2 1996 by the corporate sector just might have saved the day – for the entire period the private sector was neutral, and the big “dis-saving” from the corporate sector came in the peak of the campaign season. Households were spending, and the corporate reduction in net savings during Q2 1996 provided a tail wind.

On Q4 2011 to Q3 2012:

In the case of the 2012 election, the private sector was loosening its belt aggressively, even though fiscal policy was tightening. Most of this came early in the year, which appears to be more or less a serendipitous (for the incumbent president) sigh of relief following bouts of belt tightening following the crisis. Moreover, the fiscal tightening at the federal level should also be seen in the context of the large fiscal easing that occurred during the crisis to prop up demand. In this case, the election occurred just as the public sector was handing the economic “baton” back to the private sector.

So, what about the upcoming election? Well, it’s too early to say with any degree of certainty, but as Sparks goes on to write, “at a superficial level the modestly expansive fiscal impulse of fiscal year 2019 of 0.7% of GDP suggests… that the outlook for a second term for the Trump administration is reasonably positive”.

But not so fast. As is clear from everything noted above, it’s crucial to ask what’s going on in the private sector. On that score, the news isn’t so great for the president.

“The fiscal expansionism of the Trump administration has run into the classic problem of Ricardian equivalence”, Sparks says, before reminding everyone that “the classic example, in fact, of Ricardian equivalence occurs when the public sector cuts taxes”.

So far, so bad on that score for Trump. Through Q2 2019, the net economic stimulus from the tax cuts appears to have been almost entirely offset by private sector belt-tightening. Indeed, the chart below shows that in the two quarters immediately following the Trump tax cuts, the increase in private-sector net savings offset the fiscal belt-loosening and then some. Through the first half of 2019, there was small net stimulative effect.

(Deutsche Bank)

The key point is as follows, from Sparks:

Note that the public/private breakdown is the opposite of what was experienced before the 1992 and 2006 elections: the private sector has, on balance, been steadily tightening its belt, in spite of – and in point of fact, because of – the “belt loosening” of the public sector.

One wonders if legendary “economists” Stephen Moore and Larry Kudlow have explained that to Trump.

If so, we suppose it’s just a matter of time before the White House claims the private sector is engaged in a “deep state” economic conspiracy to undermine the MAGA economy ahead of 2020.


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