Why is the fiscal impulse fading despite ‘unsustainable’ deficits? BofA discusses By Investing.com

In a note issued earlier in the week, economists at Bank of America explored why fiscal impetus has faded despite persistently large deficits.

The bank's latest US weekly economic review noted that the slowdown in private and public investment in the first quarter of 2024 indicates that the significant fiscal support achieved last year is now waning.

“We are not surprised by this development, as we have been saying that fiscal impetus is likely to turn almost neutral this year,” the economists said in a note.

A common question clients raise is why fiscal policy does not continue to support economic growth, given “unsustainable” deficits. In attempts to address these concerns, Bank of America explains that “the level of GDP is related to the size of the deficit, but growth in GDP depends on the change in the deficit relative to the previous year.”

“We believe the confusion arises because the deficit is widely understood to be a flow variable, but GDP is sometimes mistaken for a stock, when in fact it is also a flow,” the economists added.

They also explain that large deficits do not necessarily translate into continued economic expansion. Typically, a large fiscal expansion leads to a higher level of GDP. However, if the deficit remains stable or shrinks slightly after that, the effect of fiscal policy on GDP growth (fiscal impetus) can shift from strongly positive to flat or even negative.

The Bank of America team, citing Fed Chairman Powell's comments, explained that the current fiscal path may be “unsustainable,” but this does not mean that fiscal policy remains expansionary.

To illustrate this point, Bank of America points to the ratio of primary deficit to GDP, which is currently eight-tenths lower than the same time last year, “suggesting that federal fiscal policy is a drag on growth despite rising deficit levels.” As the bank says. He said.