Cancel the Sequester
To an economist, the current fight over how much to cut the 2013 budget deficit is at best phony and at worst dangerous. The political lines are clear and predictable. This week’s bout over the sequester pits Tea Party militants, conservative pundits and most Republican office holders against the President and his Congressional allies. As it happens, most economists who pay attention also question the sequester. Their reason is straight-forward: there is simply no economic basis for immediate spending cuts—or, for that matter, immediate tax increases.
To begin, the economy is fragile enough that GDP barely grew in the 2012 fourth quarter when inventory purchases and federal spending both slowed more than usual. Just last weekend, Moody’s credit rating agency stripped the United Kingdom of its AAA credit rating—not because U.K. deficits are too high, but because Britain’s premature austerity policies are leaching away the growth required to make its deficits manageable. Moody’s decision echoed recent pronouncements by the International Monetary Fund and World Bank warning against precipitous moves to bring down cyclical deficits. The prescription for U.S. policy, then, should be clear: deep-six the sequester.
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Our political debate has linked a need for quick action against deficits to the debts run up in the 2008-2009 financial crisis and the deep recession that accompanied it. In fact, the austerity argument gained traction only when the Eurozone crisis unfolded, and Greece became the poster-country for what happens when deficits spiral upward. Back home, those looking for any reason to cut federal spending quickly cast Greece as a cautionary tale for the United States. Yet, once again, the analogy has no economic basis.
Greece’s economic crisis came about when its deficits soared and global investors pulled back. But why did they do that? To begin, Greece was and remains the Eurozone’s least productive and competitive economy, and thus the European economy least able to generate the resources required to support its deficits. That’s why interest rates on Greek debt soared. In sharp contrast, the U.S.is the world’s most productive and, arguably, competitive economy—and that’s one important reason why global investors have kept our interest rates at historically low levels even as we have faced trillion-dollar deficits.
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But economics, it seems, does not count for much in our political debate. Indeed, President Obama’s odds of prevailing this week would be greater, if those who have made careers out of fetishizing a balanced budget were not receiving quiet support from much of Washington’s split-the-difference political pros, including a clutch of Democrats. Looking out a few weeks, a chorus of self-described centrists and a few liberals could nudge the President into accepting a “compromise package” of substantial, immediate spending cuts and what Ronald Reagan used to call “revenue enhancers.” Bad policy; but if it stops there, the economic damage will be contained. But the scenario could turn worse if, as seems likely, such a compromise also becomes embedded in a Continuing Resolution that will cover the rest of the fiscal year and create a new, lower baseline for 2014.
This premature austerity inescapably will weaken the economy, raising deficits even more down the line. Worse, such a bipartisan agreement could reinforce both parties’ natural resistance to contain long-term Medicare spending and rebuild the tax base. And that could finally convince global investors that the United States has truly lost its way economically. The result would be higher interest rates, which in turn would mean even slower growth and higher deficits—as it has in Greece. What the markets want and have long expected from us is just fiscal common sense. First, Repeal the entire process of “sequestration” and instead increase federal investments in sound infrastructure, basic R&D, and access for all adults to upgrade their skills. Then follow up those measures with serious steps to contain long-term Medicare spending and expand the national tax base.
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