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Economic Research: Fiscal Initiatives Boost U.S. Economy Amid Headwinds From Tighter Monetary Policy


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Economic Research: Fiscal Initiatives Boost U.S. Economy Amid Headwinds From Tighter Monetary Policy

U.S. economic growth continues to be better than our forecasts. In the second quarter, the economy expanded 2.1% on a seasonally adjusted annualized basis after increasing 2.0% in the first quarter. The latest running estimate of real GDP growth for the third quarter is 4.8% (average of Atlanta Federal Reserve's GDPNow and S&P Market Intelligence GDP Tracker estimates), which points to yet another quarter of at- or above-trend growth pace.

Business Fixed Investment Has Been A Buffer Against Anticipated Weakness

Business fixed investment has largely shrugged off the Fed's rate hikes and tightening bank credit.   While household consumption spending (71% of GDP) has been resilient, growth has been also underpinned by a surge in business fixed investment (15% of GDP), also known as nonresidential fixed investment--particularly in structures (2.4% of GDP). Business fixed investment rose 6.1% annualized in the second quarter--an acceleration from the 0.6% increase in first-quarter 2023--and added 0.8 percentage point to real GDP growth in the second quarter (see chart 1).

While residential fixed investment (2.8% of GDP) has contracted for nine consecutive quarters, nonresidential fixed investment has been growing for 12 consecutive quarters since the recovery from the pandemic-related recession started. It has grown even as the economy went through two consecutive quarters of contraction in the first half of 2022, and as the Fed has tightened its monetary policy stance since last year.

Chart 1


The contributors to the jump in business fixed investment highlight the role of fiscal policy working through the economy.   The CHIPS and Science Act (CHIPS) and the Inflation Reduction Act (IRA) have spurred fixed investment via tax credits and loan guarantees. CHIPS was signed into law on Aug. 9, 2022. It provides roughly $280 billion in new funding to boost domestic research and manufacturing in technologies deemed critical to the U.S. energy, AI, quantum computing, and advanced manufacturing (such as of semiconductors) sectors. The IRA, with partially overlapping priorities, was passed on Aug. 16, 2022, and was designed to impact everything from transportation and the environment to prescription prices and corporate taxes.

Their contribution is noticeable in real business investment in structures, which continues to gather momentum. Investment in nonresidential structures grew 11.2% annualized last quarter, partially reflecting the surge in manufacturing construction.

Investment in manufacturing construction accelerated 94% on a seasonally-adjusted annualized rate, following a 78% expansion in the previous quarter (chart 2). Manufacturing construction has increased by over 81% since second-quarter 2022 in real terms. More specifically, facilities designed to produce semiconductors, EV battery plants, computer chips, and electronic components and equipment are experiencing huge amounts of investment (chart 3).

Chart 2


Chart 3


Semiconductor and other electronics production has kept manufacturers busy in the U.S., despite a slowdown in the overall manufacturing sector.   According to Manufacturing Dive, 39 states have seen factory and other project announcements together worth more than $86 billion. The warp speed and scale of manufacturing facility building comes at a time when business sentiment in the greater manufacturing sector has soured and activity in the overall sector has slowed down as the outsized demand post-pandemic has faded. The Institution for Supply Management's manufacturing purchasing managers index (PMI) has been below 50 since last November and growth of industrial production in the sector has stalled. But as shown in chart 4, production in the semiconductor and other electronics segment has taken flight since the second quarter of last year, bucking the greater manufacturing trend.

Chart 4


Public Sector's Infrastructure Spending Will Continue Supporting Growth

Alongside manufacturing construction, new building for public and private infrastructure following the Infrastructure Investment and Jobs Act (IIJA) is providing a broad increase in U.S. nonresidential construction spending.   IIJA was enacted in November 2021, authorizing approximately $1 trillion over ten years toward infrastructure projects that are meant to improve roads, bridges, rail, transit, ports, airports, and the electric grid. We note there is always a sizable length of time between authorization and implementation, but a simple calculation that spreads out outlays evenly over the next 10 years indicates this spending will directly add about 0.4 percentage points per year to GDP, all else equal.

We think government spending on various infrastructure projects has ramped up.   This is partly reflected in the contribution to growth from both federal and state and local governments, which has been positive in the last four quarters, adding 0.7 ppt to real GDP growth on average. (As per the U.S. Bureau of Economic Analysis' methodology, federal and state and local government infrastructure spending is counted directly in GDP accounting, unlike entitlement programs and other transfer payments.)

According to a recent report published by S&P Global Market Intelligence, infrastructure construction spending is on track to increase by 8.6% in 2023 and 7.5% in 2024, with transportation infrastructure construction poised to lead growth in both years.

Tempering A Typical Cyclical Slowdown

We think the government initiatives put in place in the last 18 months are working through the economy and partially offsetting the impact of the Fed's tightening.   The current pace of investments in manufacturing capacity is bound to slow down in coming quarters after the initial bounce. Still, positive spillover effects through equipment orders to fill the factories and warehouses that are being built and labor demand to work in them are yet to come. Further increases stemming from the CHIPS and IRA, together with infrastructure investment ramp up from IIJA, may provide material buffer against anticipated weakness in private consumption and the typical cyclical slowdown.

The outlays borne out of these fiscal incentives and direct spending are generally not sensitive to interest rates. Moreover, infrastructure investments especially tend to have higher positive spillover effects in the overall economy with larger job generation than other types of government-led investments. The multiplier effect of infrastructure investment has generally tended to be more than 1, i.e., for every dollar spent on infrastructure investment, the return on economic activity is more than a dollar. That said, we think it's possible that such multiplier effect of current fiscal stimulus may be smaller, given where we are in the economic cycle—they are coming through at a time when the economy appears to have closed the output gap and is at full employment.

In our view, once cyclically adjusted, the multiplier effect, though still positive, is likely to be lower at this stage. The government initiatives may potentially have a knock-on effect of keeping average wages elevated (due to labor shortage) and the overall economy above estimates of trend growth. As a result, inflation outlook could be persistently above target, leading the Fed to raise rates even more and thus crowding out other private-sector investment.

On the other hand, once past the short-run cyclical effects, the fiscal initiatives could generate higher productivity in the economy, lifting longer-term growth potential. For now, we think the effects of these initiatives have limited the speed and trough of a typical slowdown cycle, but we'll continue to monitor how the impacts play out in the next few years.

Related Research

  • Inflation Reduction Act: Mapping the Manufacturing Law's Impact 1 Year Later, Manufacturing Dive, Aug. 28,2023
  • Global Construction Outlook, S&P Global Market Intelligence, Aug. 21, 2023
  • Unpacking the Boom in U.S. Construction of Manufacturing Facilities, U.S. Department of Treasury, June 27, 2023

This report does not constitute a rating action.

Chief Economist, U.S. and Canada:Satyam Panday, New York + 1 (212) 438 6009;
Research Contributor:Debabrata Das, CRISIL Global Analytical Center, an S&P Global Ratings affiliate, Mumbai

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