As the economic recovery has remained weak well into its fourth year, some Washington policy makers have increasingly been blaming cuts in government spending, with much of their finger pointing at state and local governments where purchases of goods and services have slowed or declined. For example, in a speech last February Janet Yellen blamed the slow recovery in part on the fact that “State and local governments were cutting spending…”
As a matter of national income and product accounting, it is true that cuts in state and local government purchases subtract from GDP, but these cuts are mainly an endogenous consequence not an exogenous cause of the weak recovery.
Consider the following two charts. The first shows how state and local government purchases have been essentially flat in nominal terms in the past few years. But it also shows how this is largely due to the flattening out of revenues, which is, of course, caused by the weak economic recovery and resulting the slow growth of tax receipts.
The second chart shows how the purchases squeeze is exacerbated by increased transfer payments which are also caused by the weak recovery. It subtracts out transfer payments from revenues showing the funds available for purchasing goods and services. The halt in available funds and the halt in purchases in recent years are nearly perfectly synchronized.
Blaming cuts in state and local government purchases takes attention away from the real culprits in the slow recovery which are the unpredictable and uncertain monetary, fiscal, tax and regulatory policies.