Will the Sequester Really Knock Almost a Point from GDP and Cost 700,000 Jobs?
“The macroeconomic impact of the sequestration is not catastrophic.” That’s the bottom line conclusion of Macroeconomic Advisers, the highly regarded consulting firm. The US economy would grow 2.0% this year instead of 2.6% without the sequester, according to the MA economic model. This forecast is featured in a New York Times piece about the sequester, “Budget Cuts Seen a Risk to Growth of U.S. Economy.”
In addition, the across-the-board spending cuts would nudge up the unemployment rate by a quarter point, reflecting a loss of roughly 700,000 jobs by the end of 2014. But GDP growth bounces back to slightly above trend next year as the previous slowdown and rising unemployment leads “financial markets to expect a later tightening of monetary policy. This lowers long-term yields roughly enough to just offset additional fiscal drag in 2014.” Bernanke and expectations to the rescue.
1. You know what else was supposed to kill 700,000 jobs? The Obama tax hikes on small business and wealthier Americans. Just sayin’.
2. By definition, lower government spending will lower GDP in the short-term since government spending is itself a component — along with consumption, investment, and net exports — of GDP. Interestingly, the MA forecast assumes an actual spending reduction — budget outlays rather than budget authority — of just $44 billion this year, then increasing to $89 billion in 2014 and then to $102 to $110 billion after.
So how will $44 billion produce such a large — though not “catastrophic” — drop in GDP? MA uses a model with a fiscal multiplier. It assumes a change in government spending, either an increase or decrease, will produce a change in output that is some multiple or other of the initial change. These Keynesian multipliers are tricky business. Back in 2009, MA’s model predicted GDP would rise 3.7% in 2010, thanks to the stimulus-led recovery (versus the White House forecast of 3.2%). In actually, GDP rose by 2.4%. Maybe the MA multiplier is overly sensitive to changes in government spending.
Not to pick on the firm, but taking these forecasts with a grain of salt is recommended. So too the negative link between spending cuts and economic growth. As I pointed out the other day:
The U.S. fiscal deficit has fallen to about 6.5% of GDP from a peak of 10.4% in late 2009. Now how has the private-sector economy been faring during this period of government retrenchment? Not bad, all else equal. Nominal private-sector GDP has risen by 5% each of the past two years. Of course, the “all else equal” ignores the need for some catch-up years of higher-than-average growth to close the output gap. But that will require some pro-growth tax and regulatory policies not on Washington’s agenda right now. … What we are seeing is a slow reformulation of GDP, less government, more business. That’s a good thing — and the sequester will accelerate that transition.
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Comments:
Aug '10
Re: Will the Sequester Really Knock Almost a Point from GDP and Cost 700,000 Jobs?
Probably not if that is what they're telling us.
My confidence level in those people in negative territory. I use that metric to expect a 5% increase from the present sequester.
Too optimistic ?
We need a 20% sequester. We need to clean that town out and the only to do is to drive the money out of the temple first.
Sep '12
Re: Will the Sequester Really Knock Almost a Point from GDP and Cost 700,000 Jobs?
Was watching the inestimable Mr. Krauthammer on FNC last night. The numbers tossed around where $86 billion in the sequester vs. a $3600 billion budget for this year. That is a 2.4% decrease in spending.
How can that possibly lead to dog and cats living together, total chaos?
Jun '11
Re: Will the Sequester Really Knock Almost a Point from GDP and Cost 700,000 Jobs?
Don't worry... the entertainment spend for the Ricochet Integalactic Meetup planned for October will surely make up for the sequester.
Aug '11
Re: Will the Sequester Really Knock Almost a Point from GDP and Cost 700,000 Jobs?
James, you need to get your history straight. Remember the years of slow growth once we cut war spending after WW2? The 1950s were a nightmare.
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Oh, wait.
Apr '12
Re: Will the Sequester Really Knock Almost a Point from GDP and Cost 700,000 Jobs?
It seems the key is, as you say, government spending is a component in the GDP equation--most often: Private Consumption + Investment + Government Spending + (Exports - Imports) = GDP.
Besides government spending, there also are massive outlays for government contractors both in and out of the defense industry, which can enhance private sector investment and consumption (though it's still relatively zero sum in the long run). Your guess is as good as, say, John Keynes, in determining what the multiplier effect should really be.
What has to be preventing growth (to some extent) is the other side of government spending, which is to say borrowing.
Treasury Notes don't really go to foreign investors anymore, alas. The vast majority of federal debt is being borrowed from...well, ourselves.
Of the 16 trillion dollar federal debt, about $11 trillion is borrowed from We the People. Which means this $11 trillion is actually sidelined from the economy.
The fed is shoving this debt into the banking reserves, which seems to be preventing inflation--monetary velocity is relatively low.
Which is fine until the reserves fill up.
The awkward thing is, We the People have to pay the debt back.
May '10
Re: Will the Sequester Really Knock Almost a Point from GDP and Cost 700,000 Jobs?
Now I can only speak from a DoD perspective, and don't know how other federal agencies will handle their cuts, but one big hit to GDP will be when 800k DoD civilian employees take what is in essence a 20% pay cut from 1 April - 1 Oct.
Hopefully, that will prevent outright layoffs. Moving forward, there are certainly a few ways that the DoD can encourage some in its top-heavy civilian force to retire early...
But until then, the economy will lose a lot of personal spending from a big chunk of patriotic Americans...
Edited on February 22, 2013 at 3:41am