Momotumbo
03-03-2013, 06:26 PM
The Finincial Times
March 3, 2013 3:00 pm by Gavyn Davies
The legal enactment of fiscal sequestration in the US last Friday brings to an end a series of haphazard measures to tighten budgetary policy since the Obama fiscal stimulus was reversed in 2010. The overall result has been to raise $3,500 billion over the next decade, around 2 per cent of GDP.
Taken together with other measures which were already in the baseline for policy, the cumulative fiscal tightening will amount to 4.8 per cent of GDP from 2010-14, of which 1.5 percentage points will occur this year, and 0.6 percentage points will come from the sequestration order itself.
This tightening has set in stone the fiscal stance for President Obama’s second term and it will ensure that the US budgetary position is “sustainable” over that period. It is not yet clear, however, whether the economy can grow robustly while the measures take effect.
Fed Chairman Ben Bernanke described the sequestration order as being like the nuclear bomb which was detonated accidentally in the 1964 movie “Dr Strangelove”. The course of American fiscal policy in recent times has progressed in random steps with no coherent hand apparently in control. The overall result, a large fiscal tightening dominated by savings in the discretionary outlays of the federal government, with relatively modest increases in taxation, seems to accord more with basic Republican, rather than Democratic, principles. This is why it has been bitterly criticised on the liberal side of the fence, notably by Keynesians who view it as being both unnecessary and damaging. (See Martin Wolf’s recent column on global austerity here.)
Interestingly, though, the markets have shown very little sensitivity to the most recent episodes of the Washington fiscal soap opera. US equities have ignored the President’s warnings of imminent crisis, and have continued to trade near to all time highs throughout the sequestration negotiations. So does this mean that the US, as democracies sometimes do, has accidentally stumbled upon a lowest common denominator which will actually work?
No-one would claim that sequestration itself is the best way to proceed. Because a full year’s cuts will be crammed into half a year, they will involve across-the-board reductions of 13 per cent in defence outlays, and 9 percent cuts in non defence discretionary outlays, over the balance of the 2013 fiscal year [1]. This cannot happen without doing many things which will be counter-productive.
Furthermore, since the cuts do not apply to entitlement programmes like social security and much of medical care, they do not have any impact on the areas of major growth in US federal spending which are the real threat to fiscal sustainability in the coming decades. Instead, they will hit items like public investment in infrastructure and research, which should be protected in any cuts package. Finally, they will be front end loaded when America’s fiscal problem is back-end loaded. Mr Bernanke joined a strong consensus among economists when he said last week that the measures are the wrong way round in that respect.
The packages have, however, done enough to bring the budget deficit and government debt ratios under control for this Presidential term, thus reducing the risk of a fiscal crisis in the immediate future. True, this risk may never have been very large. An interesting research paper recently published by the IMF points out that the risk of a crisis depends not only on the supply of public debt, but also on the demand for that debt. After examining the demand for US public debt compared to that in other countries, it concludes that America (like Japan and the UK, incidentally) should be resilient to a crisis, because the holders of its debt are unlikely to exit in a hurry. Still, it is surely an advantage that the debt ratio, on the CBO’s latest estimates, will now stabilise at around the current level over the rest of this decade.
That relatively optimistic path for the debt ratio depends on the belief that the economy will be able to absorb the fiscal tightening without falling back into recession. The US approach to fiscal policy has now joined other economies like the UK and the eurozone which have failed to pull off this trick. In fact, the cumulative tightening in the US fiscal stance (4.8 per cent of GDP from 2010-14) will be larger than that planned in the eurozone (4.1 per cent), which has been heavily criticised in America for tightening policy too quickly. Perhaps the key question for global markets in the remainder of this year is whether they have been right to assume that the US economy can sail through this fiscal shock relatively unscathed.
We will soon know the answer. The major test of US economic resiliency will be faced in the immediate future. According to estimates from Goldman Sachs, the combined impact of the fiscal measures will be to reduce real GDP growth in 2013 Q2 and Q3 by 2.5 per cent, which is equivalent to the whole of the underlying rate of “trend” growth in this period. In other words, the private sector will need to grow at above trend rates if the published GDP figures are to show any positive growth at all.
Fortunately, it appears that the private sector is ready to accomplish this. In contrast to the fiscal tightening in the eurozone and the UK, the US has waited until the private sector deleveraging has started to abate before slamming on the fiscal brakes. Furthermore, unlike the eurozone, the US has a central bank which still appears committed to doing whatever it takes to maintain GDP growth as the budget deficit is corrected. Mr Bernanke’s speech in San Francisco this weekend has once again clarified this, after a couple of weeks of market uncertainty about the Fed’s true intentions.
The markets are aware that, if the US can get through the “fiscal hump” in the next two quarters, then it should be relatively plain sailing thereafter, since the private sector expansion should progressively overtake the declining fiscal drag. That looks the most likely outcome, but in view of the difficulties which other countries have encountered when fiscal policy has been tightened, it is far less assured than the markets seem to think. Some interesting times lie immediately ahead.
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Footnotes
[1] Previous attempts to cut spending through sequestration have often failed before the cuts have actually taken effect. See this research by the Bipartisan Policy Center. There is still time for Congress to change its mind on the scheduled cuts, but it now seems unlikely that this will happen unless the cuts are replaced with other budget savings elsewhere.
March 3, 2013 3:00 pm by Gavyn Davies
The legal enactment of fiscal sequestration in the US last Friday brings to an end a series of haphazard measures to tighten budgetary policy since the Obama fiscal stimulus was reversed in 2010. The overall result has been to raise $3,500 billion over the next decade, around 2 per cent of GDP.
Taken together with other measures which were already in the baseline for policy, the cumulative fiscal tightening will amount to 4.8 per cent of GDP from 2010-14, of which 1.5 percentage points will occur this year, and 0.6 percentage points will come from the sequestration order itself.
This tightening has set in stone the fiscal stance for President Obama’s second term and it will ensure that the US budgetary position is “sustainable” over that period. It is not yet clear, however, whether the economy can grow robustly while the measures take effect.
Fed Chairman Ben Bernanke described the sequestration order as being like the nuclear bomb which was detonated accidentally in the 1964 movie “Dr Strangelove”. The course of American fiscal policy in recent times has progressed in random steps with no coherent hand apparently in control. The overall result, a large fiscal tightening dominated by savings in the discretionary outlays of the federal government, with relatively modest increases in taxation, seems to accord more with basic Republican, rather than Democratic, principles. This is why it has been bitterly criticised on the liberal side of the fence, notably by Keynesians who view it as being both unnecessary and damaging. (See Martin Wolf’s recent column on global austerity here.)
Interestingly, though, the markets have shown very little sensitivity to the most recent episodes of the Washington fiscal soap opera. US equities have ignored the President’s warnings of imminent crisis, and have continued to trade near to all time highs throughout the sequestration negotiations. So does this mean that the US, as democracies sometimes do, has accidentally stumbled upon a lowest common denominator which will actually work?
No-one would claim that sequestration itself is the best way to proceed. Because a full year’s cuts will be crammed into half a year, they will involve across-the-board reductions of 13 per cent in defence outlays, and 9 percent cuts in non defence discretionary outlays, over the balance of the 2013 fiscal year [1]. This cannot happen without doing many things which will be counter-productive.
Furthermore, since the cuts do not apply to entitlement programmes like social security and much of medical care, they do not have any impact on the areas of major growth in US federal spending which are the real threat to fiscal sustainability in the coming decades. Instead, they will hit items like public investment in infrastructure and research, which should be protected in any cuts package. Finally, they will be front end loaded when America’s fiscal problem is back-end loaded. Mr Bernanke joined a strong consensus among economists when he said last week that the measures are the wrong way round in that respect.
The packages have, however, done enough to bring the budget deficit and government debt ratios under control for this Presidential term, thus reducing the risk of a fiscal crisis in the immediate future. True, this risk may never have been very large. An interesting research paper recently published by the IMF points out that the risk of a crisis depends not only on the supply of public debt, but also on the demand for that debt. After examining the demand for US public debt compared to that in other countries, it concludes that America (like Japan and the UK, incidentally) should be resilient to a crisis, because the holders of its debt are unlikely to exit in a hurry. Still, it is surely an advantage that the debt ratio, on the CBO’s latest estimates, will now stabilise at around the current level over the rest of this decade.
That relatively optimistic path for the debt ratio depends on the belief that the economy will be able to absorb the fiscal tightening without falling back into recession. The US approach to fiscal policy has now joined other economies like the UK and the eurozone which have failed to pull off this trick. In fact, the cumulative tightening in the US fiscal stance (4.8 per cent of GDP from 2010-14) will be larger than that planned in the eurozone (4.1 per cent), which has been heavily criticised in America for tightening policy too quickly. Perhaps the key question for global markets in the remainder of this year is whether they have been right to assume that the US economy can sail through this fiscal shock relatively unscathed.
We will soon know the answer. The major test of US economic resiliency will be faced in the immediate future. According to estimates from Goldman Sachs, the combined impact of the fiscal measures will be to reduce real GDP growth in 2013 Q2 and Q3 by 2.5 per cent, which is equivalent to the whole of the underlying rate of “trend” growth in this period. In other words, the private sector will need to grow at above trend rates if the published GDP figures are to show any positive growth at all.
Fortunately, it appears that the private sector is ready to accomplish this. In contrast to the fiscal tightening in the eurozone and the UK, the US has waited until the private sector deleveraging has started to abate before slamming on the fiscal brakes. Furthermore, unlike the eurozone, the US has a central bank which still appears committed to doing whatever it takes to maintain GDP growth as the budget deficit is corrected. Mr Bernanke’s speech in San Francisco this weekend has once again clarified this, after a couple of weeks of market uncertainty about the Fed’s true intentions.
The markets are aware that, if the US can get through the “fiscal hump” in the next two quarters, then it should be relatively plain sailing thereafter, since the private sector expansion should progressively overtake the declining fiscal drag. That looks the most likely outcome, but in view of the difficulties which other countries have encountered when fiscal policy has been tightened, it is far less assured than the markets seem to think. Some interesting times lie immediately ahead.
——————————————————————————————-
Footnotes
[1] Previous attempts to cut spending through sequestration have often failed before the cuts have actually taken effect. See this research by the Bipartisan Policy Center. There is still time for Congress to change its mind on the scheduled cuts, but it now seems unlikely that this will happen unless the cuts are replaced with other budget savings elsewhere.