Much has been made of the fact that this economic recovery has lost steam as of late. The US monthly jobs reports have not been encouraging, resulting in an unemployment rate that remains persistently high. But a major cause for this slow economy is the fact that, contrary to popular belief, reductions in government spending are a key reason for the growth slowdown.
In 2010, the US federal government's deficit was actually $120 billion lower than it was in 2009. This represents almost 1% of US GDP; therefore, without this headwind, real US GDP growth for 2010 would likely have been higher than 2.9%, which is not enough to meaningfully reduce the unemployment rate. This is because population and productivity growth by themselves can usually be counted on to add 3% or so annually to real GDP, and so only by growing at more than 3% annually will the economy require the help of additional workers.
That trend appears to have continued so far this year. Though real US GDP grew at an annualized rate of just 1.9% in the first quarter of 2011, it did so despite an 8.1% drop in federal government spending and a 4.2% drop in state and local government spending. Since government spending makes up around 20% of GDP, reductions of this nature have a significant effect on GDP.
In other recessions, governments have been able to spend their way out of the economic malaise. For example, the increased spending required by World War II is largely credited with ending the Great Depression. Furthermore, government deficits increased in the three years that followed the recession of 2001, which helped the economy regain its footing.
Today, however, debt levels are high by historical standards. This has reduced the political will to incur further deficits to spend our way out. As such, we should be prepared to incur lower GDP growth numbers for some time. There's no need to panic over this, as it is simply the result of our choice between robust growth and responsible debt management. Once deficits are reduced to what are perceived to be sustainable levels, the drag on the economy will no longer be present and a return to a better growth trajectory can resume.