Tuesday, January 03, 2012

Question #7 for 2012: State and Local Governments

by Bill McBride on 1/03/2012 04:14:00 PM

Earlier I posted some questions for next year: Ten Economic Questions for 2012. I'm trying to add some thoughts, and a few predictions for each question.

Many of the questions are interrelated. The question on monetary policy depends on inflation (question #9), the unemployment rate (question #6) and what happens in Europe (question #8). And the unemployment rate is related to GDP growth (question #4), and on and on ...

Question #7: State and Local Governments: It is starting to look like there will be less drag in 2012 than in 2011. How much of a drag will state and local budget problems have on economic growth and employment?

How about this headline from Bloomberg this morning: Michigan Fiscal Agency Anticipates $735 Million Budget Surplus for 2011-12? This doesn't mean the cuts are over because the budget assumes further cuts, especially for education. But it suggests progress.

There was a similar article about California a couple of weeks ago in the San Francisco Chronicle: California leaders say time for cuts may be ending. Once again there are more cuts coming, but the end may be in sight.

The National Conference of State Legislatures (NCSL) recently released a report "State Budget Update: Fall 2011,":

State fiscal conditions continue to improve, but at a very slow pace. A fall 2011 survey of state legislative fiscal officers found that the deterioration that dominated state finances in recent years has eased. Revenue performance has improved, expenditures in most states are stable and, in a significant departure from past years, few states are reporting budget gaps in the early months of fiscal year (FY) 2012. However, despite these positive developments, the effects of the Great Recession continue to linger. State tax collections still remain well below pre-recession levels.

With the enactment of their FY 2012 budgets, lawmakers successfully closed a cumulative budget gap of $91 billion. This is on top of shortfalls that states began
addressing in FY 2008. In total, lawmakers have resolved an aggregate gap of more than $500 billion over four consecutive years. But the tide may be turning. Halfway into the second quarter of FY 2012, new gaps are practically non-existent.
Note: "Fiscal years for all but four states—Alabama, Michigan, New York, and Texas—begin on July 1.", Source. So the FY 2012 budgets (and associated cuts) will end on June 30, 2012.

Here is a table of the annual change in state and local GDP and payroll employment for the last several years. State and local governments have been a significant drag on both GDP and payroll employment.

State and Local Government
Change, Employment (000s)Change in Real GDP

Note: estimate for 2011, forecast for 2012 (aka guess).

It is looking like there will be less drag from state and local governments in 2012, and that most of the drag will be over by the end of Q2 (end of FY 2012). This doesn't mean state and local government will add to GDP in the 2nd half of 2012, just that the drag on GDP and employment will probably end. Just getting rid of the drag will help.

This is a significant improvement from last year!

A final comment: there was a debate last year if there would be a large number of muni defaults in 2011. One analyst predicted "hundreds of billions of dollars' worth of defaults". I disagreed strongly with that prediction, and the total defaults was only a small fraction of that number. With improving finances, the threat of a huge number of muni defaults is even less likely in 2012.

Question #8 for 2012: Europe and the Euro
Question #10 for 2012: Monetary Policy
Question #9 for 2012: Inflation

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