Robert Kahn

Macro and Markets

Robert Kahn analyzes economic policies for an integrated world.

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Sequester, Day 1

by Robert Kahn
March 1, 2013


Does today feel different?  Did the earth shake?  Packing your lunch rather than buy out?

Welcome to the sequester.

Another manufactured fiscal crisis has failed to produce smart policies.   The effects of this failure will take time to be felt, a “slow ripple of pain” as Politico puts it in their note on the timing of the cuts.  Furloughs notices have to be sent out, agencies will try and smooth or delay the disruptions to services, and no doubt some of the dire warnings are overdone.  But by April we would see material disruptions to services.  That fact, plus rising public unhappiness, makes the sequester unsustainable on economic or political grounds.

The next cliff, the March 27 continuing resolution (CR) funding the government, provides a good opportunity to address the sequester, either by providing greater flexibility to the administration in applying the cuts or by backloading and replacing the cuts with other measures.  If the CR fails to address it, the debate could spill into April or May, when the dislocations from layoffs and cutbacks become more critical and perhaps even bring the debt limit debate back into play.

How big a hit?

The $85 billion in cuts for FY13 that go into effect today will reduce discretionary appropriations to below 2008 levels.  Defense programs will be cut 13 percent and affected non-defense programs by about 9 percent.  Because these are cuts to budget authority and some programs pay out over several years, the direct effects on government spending this fiscal year will be smaller, around $45 billion.  Macroeconomic Advisers, in a well-publicized and detailed study, estimated the sequester would cut GDP by 0.6 percent of GDP for 2013 (to 2 percent).  By the end of 2014, the sequester would cost 700,000 jobs and raise the unemployment rate to 7.4 percent.  The Fed would delay tightening.

On one level, this seems manageable in a $16 trillion economy, relative to the warnings that have preceded it. However, it’s hard to account for the effects of a broader disruption in the provision of basic services and public goods. Long waits for planes, delays in food inspection or medical services, and the like could disrupt activity to a far greater degree than these estimates suggest.

Macroeconomic Advisers (2/20/13)

Markets appear to have responded to the onset of the sequester by…ignoring it.  Recent volatility has reflected renewed fears for Europe in the wake of Italian elections, uncertainty about Fed policy, and currency wars.  It’s hard to pinpoint an independent sequester effect.  Perhaps this reflects cynicism that Congress will find a way to kick the can. Perhaps, instead, it’s “cliff fatigue”.

Nonetheless, it’s hard not to conclude that the series of endless fiscal cliffhangers is beginning to have an effect on activity. Recent surveys show consumer confidence has been affected, and business investment delayed, due to uncertainty about fiscal policy.

What next?

I have previously written that the window for a grand bargain is closing.  Each previous effort has fallen short, leaving scar tissue and distrust that make it more difficult to negotiate the next time.  In addition, the deficit reduction that we have achieved may be taking the pressure off our leaders to deal comprehensively with our fiscal deficit.

Three years of fiscal showdowns have produced around $2.7 trillion in budget savings, primarily through new revenue and cuts to discretionary spending programs.  CBO now expects the fiscal deficit to fall below 4 percent next year, and to 2 1/2 percent in FY15.  While this is not enough to fix our long-term fiscal problem, it is enough to stabilize the debt at a little over 70 percent of GDP for the next several years before rising interest rates, an aging population and rising medical costs cause the debt to again rise.

I continue to hope that a grand bargain can be reached that addresses entitlements, tax reform and the other fundamental drivers of deficit. It would be far better to address the problem now rather than later when a market revolt or the inescapable math of our fiscal problem produces a crisis.  But if that is not possible, it may be time to recognize that fact and find a way to defuse the sense of constant fiscal crisis.  Let’s fight over immigration, gun control and other key priorities. We need an exit strategy.

Post a Comment 3 Comments

  • Posted by Richard Eastman

    Neither you, nor the White House, nor Congress, nor other economists and financial journalists discuss sequestration as deflation. Is there are reason for this? And what is the difference between what we are getting and what Greece and Ireland have gotten?

  • Posted by Robert Kahn

    Richard — You are absolutely right that the sequester imparts a deflationary shock to demand. I’m also sympathetic to the argument that, with substantial slack in the economy and interest rates near zero, the drag on the economy could be larger than Macroeconomic Advisers suggest (a higher multiplier). This strengthens the case for backloading cuts (and, in context of grand bargain, some near term spending on key priorities such as infrastructure and education). But I don’t think this will lead to Japan-style deflation because if we started down that road the Fed would respond aggressively (and commit to stay easy longer). Market expectations of easing plus exchange rate depreciation would short-circuit the deflationary dynamics. From this perspective, the stability of US inflationary expectations over the last couple of years of deficit reduction is notable. By comparison, the shocks in the periphery of Europe were much larger, both in absolute terms and relative to the monetary policy response. For example, Greece has seen an output decline of 20 percent on a fiscal effort (cyclically adjusted) of around 15 percent. The ECB’s response, while cumulatively significant, was hesitant and far tighter than would be appropriate for the periphery alone.

  • Posted by alan

    You really don’t understand. It’s the end of New Deal Economics. The era of racking up debt and promises is coming to an end. The Democrats have based their entire lives on taking money, in the form of debt and promises, and then paying off their supporters. Without any more debt and promises, the Democrats come to an end. Of course, Democrats are going to fight tooth and nail to keep the party going. That’s why they refuse to come up with a budget. Somebody’s ox would get gored. To expect an easy mutual reconciliation is absurd. If your freebies were taken, you would fight tooth and nail to keep them. That is why you are seeing riots in Greece, France, etc. The fighting will keep on going until the money runs out. The Republicans and Tea Party are trying to cut spending, but compared to the hundreds of trillions of dollars in debt and promises, it’s too late. The riots have begun. The Democrats want to keep on taking money so they can spend it, so there will be no reconciliation.

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