“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.