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US government spending cuts will hurt job growth and recovery
By Laura Tyson |
February 28, 2013, Thursday
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Print Edition
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THE United States is confronting another round of cuts in federal government spending, this time threatening to trim at least 0.5 percentage points from GDP growth and to precipitate a loss of at least one million jobs.
Automatic across-the-board spending cuts, the so-called "sequester," would reduce spending by US$85 billion, with defense programs cut by about 8 percent and domestic programs by about 5 percent this year - and with additional cuts of comparable dollar amounts every year until 2021.
All major government functions - national security, foreign aid, basic research, emergency relief, and education, to name a few salient examples- would experience an immediate and sizeable funding hit. These cuts, along with the tax increases agreed to in January, would knock about 1.25 percentage points off 2013 GDP growth.
The real aim of the sequester's advocates is a smaller federal government - a goal that often is cloaked in the argument that excessive government spending is choking economic growth. Although this is a politically compelling argument, because it stokes public fears about an out-of-control deficit, it flies in the face of the facts.
Anemic government spending, not profligacy, has been a major factor behind the economy's lackluster recovery. According to a recent report by the Congressional Budget Office, large spending cuts by state and local governments - and, more recently, a significant reduction in federal spending - have contributed to the unusual and prolonged weakness of aggregate demand.
In recent speeches, US Federal Reserve Chairman Ben Bernanke and Vice Chair Janet Yellen have described fiscal policy at the local, state, and federal levels as a powerful headwind slowing the economy's return to full employment. In the year after the recession ended, discretionary spending at the federal, state, and local levels boosted growth at about the same pace as in previous recoveries.
Contractionary policy
But, since then, fiscal policy has become contractionary, reducing aggregate demand and restraining growth.
Even without the sequester, real per capita government spending (including both purchases and transfer payments) has declined under President Barack Obama, while it increased under every preceding president since Richard Nixon.
And, even without the sequester, the federal budget deficit is set to fall at a faster pace during the next two years than in any two-year period since demobilization after World War II. As a result of a deep and persistent deficiency in aggregate demand, the US economy has been operating far below its potential output level.
The significant loss of current and future potential output is all the more remarkable, because it has occurred despite a sustained and unprecedented effort by the Fed to boost demand and hasten the recovery.
Fed officials have repeatedly expressed concern that the prolonged weak recovery will inflict future pain in the form of slower long-run growth.
Motivated by this concern, the Fed has held the nominal short-term interest rate near zero for more than five years, with a promise to keep it there until 2015, and has been purchasing about US$1 trillion of long-term government bonds each year.
As a result, the nominal yield on the 10-year Treasury bond, a widely used measure of the federal government's borrowing costs, hovers around 2 percent. That is higher than the record low of 1.4 percent hit in 2012, but less than half the pre-2008 level and less than a third of its 40-year average. In real terms, both short-term and long-term interest rates remain in negative territory.
Recent research has found that the multiplier for discretionary fiscal policy - the change in output caused by a change in discretionary government spending - is larger when nominal interest rates are low and there is a significant amount of underutilized resources.
These conditions describe the US economy as it faces yet another round of government spending cuts that would have negative multiplier effects on GDP and job growth.
Indeed, these effects are likely to be larger than expected compared to conventional multiplier estimates, which rest on two assumptions: the economy is close to full employment; and the contraction in demand caused by a cut in government spending will be offset by a drop in interest rates. Neither assumption applies today.
Even worse, the sequester's across-the-board spending cuts make no distinction between effective and essential programs and programs that represent special interests or have outlived their original purpose.
The sequester is the product of ideology and political stalemate. It has no economic justification.
In the long run, additional targeted spending cuts will be necessary as part of a balanced package to stabilize the debt/GDP ratio. But they are not necessary now. Indeed, by endangering the economy's halting recovery, they would be counterproductive.
Laura Tyson, a former chair of the US President's Council of Economic Advisers, is a professor at the Haas School of Business at the University of California, Berkeley. Copyright: Project Syndicate, 2013.www.project-syndicate.org. Shanghai Daily condensed the article.
Automatic across-the-board spending cuts, the so-called "sequester," would reduce spending by US$85 billion, with defense programs cut by about 8 percent and domestic programs by about 5 percent this year - and with additional cuts of comparable dollar amounts every year until 2021.
All major government functions - national security, foreign aid, basic research, emergency relief, and education, to name a few salient examples- would experience an immediate and sizeable funding hit. These cuts, along with the tax increases agreed to in January, would knock about 1.25 percentage points off 2013 GDP growth.
The real aim of the sequester's advocates is a smaller federal government - a goal that often is cloaked in the argument that excessive government spending is choking economic growth. Although this is a politically compelling argument, because it stokes public fears about an out-of-control deficit, it flies in the face of the facts.
Anemic government spending, not profligacy, has been a major factor behind the economy's lackluster recovery. According to a recent report by the Congressional Budget Office, large spending cuts by state and local governments - and, more recently, a significant reduction in federal spending - have contributed to the unusual and prolonged weakness of aggregate demand.
In recent speeches, US Federal Reserve Chairman Ben Bernanke and Vice Chair Janet Yellen have described fiscal policy at the local, state, and federal levels as a powerful headwind slowing the economy's return to full employment. In the year after the recession ended, discretionary spending at the federal, state, and local levels boosted growth at about the same pace as in previous recoveries.
Contractionary policy
But, since then, fiscal policy has become contractionary, reducing aggregate demand and restraining growth.
Even without the sequester, real per capita government spending (including both purchases and transfer payments) has declined under President Barack Obama, while it increased under every preceding president since Richard Nixon.
And, even without the sequester, the federal budget deficit is set to fall at a faster pace during the next two years than in any two-year period since demobilization after World War II. As a result of a deep and persistent deficiency in aggregate demand, the US economy has been operating far below its potential output level.
The significant loss of current and future potential output is all the more remarkable, because it has occurred despite a sustained and unprecedented effort by the Fed to boost demand and hasten the recovery.
Fed officials have repeatedly expressed concern that the prolonged weak recovery will inflict future pain in the form of slower long-run growth.
Motivated by this concern, the Fed has held the nominal short-term interest rate near zero for more than five years, with a promise to keep it there until 2015, and has been purchasing about US$1 trillion of long-term government bonds each year.
As a result, the nominal yield on the 10-year Treasury bond, a widely used measure of the federal government's borrowing costs, hovers around 2 percent. That is higher than the record low of 1.4 percent hit in 2012, but less than half the pre-2008 level and less than a third of its 40-year average. In real terms, both short-term and long-term interest rates remain in negative territory.
Recent research has found that the multiplier for discretionary fiscal policy - the change in output caused by a change in discretionary government spending - is larger when nominal interest rates are low and there is a significant amount of underutilized resources.
These conditions describe the US economy as it faces yet another round of government spending cuts that would have negative multiplier effects on GDP and job growth.
Indeed, these effects are likely to be larger than expected compared to conventional multiplier estimates, which rest on two assumptions: the economy is close to full employment; and the contraction in demand caused by a cut in government spending will be offset by a drop in interest rates. Neither assumption applies today.
Even worse, the sequester's across-the-board spending cuts make no distinction between effective and essential programs and programs that represent special interests or have outlived their original purpose.
The sequester is the product of ideology and political stalemate. It has no economic justification.
In the long run, additional targeted spending cuts will be necessary as part of a balanced package to stabilize the debt/GDP ratio. But they are not necessary now. Indeed, by endangering the economy's halting recovery, they would be counterproductive.
Laura Tyson, a former chair of the US President's Council of Economic Advisers, is a professor at the Haas School of Business at the University of California, Berkeley. Copyright: Project Syndicate, 2013.www.project-syndicate.org. Shanghai Daily condensed the article.
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