Even as the Massachusetts economy shows some genuine signs of strength, contractionary federal government fiscal policy is manifestly slowing economic growth in Massachusetts. In the coming months, assuming these policies stay in place, a further retarding of economic growth can be expected. At the same time, the state's labor market continues to be under considerable stress and faces profound challenges that are not fully reflected in the state's headline unemployment rate.

The strengthening of the state housing market is the most prominent sign of strength in the state economy. Residential house prices, sales, and building permits are all on the rise. As a result, employment in the construction sector is increasing but it remains well below its pre-recession levels. The unemployment rate, despite a recent uptick, remains one percentage point below the national level. Strong state sales tax collections reflect the willingness of households to spend, especially for new automobiles.

But these signs of life are being undermined by federal tax and budget policies that have been implemented since the first of the year. On the tax side, income tax rates were increased for upper income households on January 1st. In addition, the temporary payroll tax cut, which had been implemented during the recession, was not extended. This has a more widespread impact, with a disproportionate burden being placed on low-income households. Had these tax increases been offset by increased federal investment their impact would have been modest, but instead the federal government elected to adopt significant spending cuts.

Federal budget sequestration, implemented in March, has an obvious impact on the state's research-intensive enterprises and government contractors. But its impact also extends to Head Start and other educational programs, career centers and job training services, and Community Development Block Grant funds, all of which have experienced significant cuts in recent months.

The impact of these federal policies can be seen in the state's recent economic performance. According to the MassBenchmarks Current Economic Index, growth in state gross domestic product slowed to a one percent annualized rate of growth in April and May. Employment growth in the state has virtually stalled, and state withholding tax growth reflects this. And growing international competition and the economic challenges facing the state's major trading partners, including Canada, the European Union, and Asia, appear to be taking their toll on the Commonwealth's export activity, which declined by 11.1 percent between April 2012 and April 2013.

While labor conditions in Massachusetts appear to be better than those nationally, there are signs of considerable stress in the state labor market. Underemployment (those working part-time but wanting full-time work) has risen during the first five months of the year, and hidden unemployment (those who are out of work, have not looked for a job in the last four weeks, and would take a job if offered) is also on the rise. The plight of younger and less skilled workers is of particular concern as the extent of their disconnection from the labor market is troublingly high and the longer it lasts the more difficult it will be to remedy. For these workers, the improvement in headline unemployment is of little consolation, as their prospects for employment are being limited by a recovery that is being undermined by counterproductive federal policy choices.

This summary reflects the discussion of the members of the Editorial Board of MassBenchmarks at its meeting on June 21, 2013. It was prepared by Executive Editor Robert Nakosteen and was reviewed and edited by the members of the Editorial Board. While discussion among the Board members was spirited and individual Board members hold a wide variety of views on current economic conditions, this summary reflects the consensus view of the Board regarding the current state of the Massachusetts economy.

MassBenchmarks is the journal of the Massachusetts economy and is published by the UMass Donahue Institute in collaboration with the Federal Reserve Bank of Boston. Its editorial board is made up of leading economic analysts from across Massachusetts. The opinions expressed by the Editorial Board do not necessarily represent the opinions of the Federal Reserve or the University of Massachusetts.