BlackRock Investment Institute

Macro insights

State austerity could weigh on U.S. activity

The U.S. will soon face a fiscal cliff unless fresh stimulus is agreed in the coming weeks. Key elements of the stimulus package – notably the federal top up to unemployment insurance – could be curtailed prematurely, in our view. As the budget situation deteriorates as a result of the economic slump, state and local governments could be forced to cut back on spending to balance their books – just when support is needed most.

The main measures of fiscal relief for households include individual stimulus payments totalling over $3 trillion on an annualised basis since April – far in excess of what we saw during the global financial crisis (GFC). And a $600-a-week federal top-up to the unemployment insurance payments raised the replacement rate of median earnings from just under 50% to just over 100%. Both have provided vital support to incomes, but the household payments have largely finished and the unemployment insurance top-up is scheduled to expire at the end of this month.

U.S. companies have benefited primarily through the Paycheck Protection Program (PPP), which has provided over $530bn of loans – especially to small and medium sized firms. These loans have underpinned cash flows during business closures. But the window for using PPP loan cash is starting to close, raising the risk of insolvencies and additional layoffs.

Contributions to real GDP growth, 2000-2020

Source: BlackRock Investment Institute and the Hutchins Center on Fiscal and Monetary Policy, with data from Haver Analytics. Note: The bars show the estimated fiscal impulse from federal and state and local spending, and tax and benefit programs, measured as the percentage point contribution to real GDP growth as a four-quarter moving average. The 2020 bars are Hutchins Center estimates. Forward looking estimates may not come to pass.

At the state and local level, there is the risk of another fiscal cliff-edge. Early estimates from the Center on Budget and Policy Priorities point to state and local tax revenue shortfalls of up to 10% in the 2020 fiscal year, and 10-20% in key states in 2021. The cumulative shortfall could be over $555 billion between 2020 and 2022 and so state governments could be forced into a painful austerity drive. There is growing evidence of public sector employees being put on furlough. The Hutchins Center estimates that state and local austerity weighed significantly on GDP growth in the aftermath of the GFC, and projects an even sharper fiscal drag this year. See the chart above.

State and local government employment has already fallen by around 5% from pre-Covid levels and – unlike private payrolls – has not yet rebounded.  Federal employment, by contrast, has remained broadly stable. State and local employment cuts were a main channel through which austerity dented activity in the aftermath of the GFC, so it’s important to keep an eye on this.

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