If you hate hearing “I told you so” stories, stop reading.
Nine months ago, policymakers on both sides of the political aisle were rightfully voicing concerns over the “fiscal cliff” slated to take effect January 1, 2013. Those legislated spending cuts and tax increases threatened to push the moribund economy back into recession. Today, the lessons that should have been learned from the panic over the cliff are sorely missing. Congress adjourned for August recess without any meaningful action to moderate fiscal restraint, just as the cost of that deal is becoming more manifest.
At its core, the challenge posed by the fiscal cliff was that budget deficits closing too quickly — and public debt rising too slowly — threatened to choke off growth and push the economy into an austerity-induced recession. But the surrounding political debate and the ensuing lame duck budget deal were intrinsically fixated with simply avoiding a double-dip recession — far too low a bar.
As recently underscored by revisions to U.S. gross domestic product, the pace of economic expansion has decelerated markedly over the past year — more so than previously understood.
Growth has slowed so much that the U.S. economy has recently been regressing away from recovery. Generating a full economic recovery should have been the unwavering top policy objective for the past five years, but lawmakers dropped that ball in favor of premature deficit reduction executed in a particularly foolish manner.
Specifically, sizable federal spending cuts — the “resolution” to the 2011 debt ceiling crisis and government shutdown threats earlier that year — and the subsequent failure to actually correct the problem of overly rapid deficit reduction is to blame for the lack of further economic progress this year.
Just how weak has the economy been? As a rough compass, real GDP growth must exceed a range of roughly 2 percent to 2.5 percent annually in order for the demand-depressed economy to make progress toward recovery. The revised data from the Bureau of Economic Analysis show real GDP growing 1.3 percent in the year to the first quarter of 2013, down from a 1.8 percent reading from the old data. Moreover, the new data show real GDP growth decelerating more sharply, falling from a 3.1 percent growth rate in the year through the third quarter of 2012 to a 0.6 percent annual pace in the six months that followed.
This deceleration of growth effectively predates sequestration, but nonetheless coincides (contrary to popular perception) with rapid reduction in the federal budget deficit as a share of GDP — a trend that will continue to restrain growth. On this front, the inaptness of the “cliff” metaphor surely didn’t help.
As Josh Bivens of the Economic Policy Institute and I argued (PDF), the false dichotomy implied by a cliff was a poor framing of both the problem and policy choices actually at hand. This framing helped suggest that the eventual lame duck budget deal was successful because the economy didn’t crash in January 2013. But the budget deal didn’t resolve the problem of deficits closing too quickly, which always risked an ongoing deceleration in growth before and after January, not an immediate double-dip recession.
Instead of easing the largest economic drags, the budget deal mostly resolved politically contentious disagreements about taxing the top 1 percent of households by income—which has almost no impact on aggregate demand and recovery. Sequestration spending cuts were delayed for a negligible two months and underlying discretionary spending cuts were left to continue ratcheting down.
The legislated fiscal restraint that was prevented as part of the cliff deal loomed large in budgetary terms, but avoiding those tax hikes, broadly speaking, was a relatively ineffective way of stimulating the economy. The agreement to extend Bush-era income tax cuts for 99 percent of households, adjust the alternative minimum tax for inflation and continue a slew of other annually extended tax cuts and credits was never designed to provide real fiscal stimulus. Those policies overwhelmingly demonstrated low fiscal multipliers; there was also never much doubt that these tax cuts would be continued. On the other hand, the payroll tax cut, which provided better-targeted stimulus, was allowed to expire without a whimper from either party. The major exception was continuing emergency unemployment benefits (albeit at reduced levels relative to most of 2012) — excellent economic support that was by no means guaranteed. But overall, the deal further shrank the budget deficit relative to “current policy” baselines being used at the time.
The fiscal cliff deal also delayed sequestration from taking effect for two months, but did nothing more to avoid the foolishness of those mandated cuts, which will become more noticeable in the second half of this year and into 2014. The reasons for that have to do with the details of the federal budgeting and spending process. Legislated spending cuts reduced the government’s budget authority – the authority to enter into contracts that will result in spending.
That by itself reduces demand somewhat, but the full effects only become visible over time; only 55 percent to 60 percent of one year’s reduction in discretionary budget authority will translate to reduced outlays that same year. Some pundits have suggested that sequestration will not prove as bad as hyped, but the only “good news” here means worse news for next year as reduced budget authority leads to cuts in actual spending. After the sequester for fiscal 2013 begins to exert a more noticeable drag in the third quarter of the year, the start of the new fiscal year in October will see bigger underlying discretionary spending cuts, and larger sequestration cuts seem poised to hit in December or January.
The larger sequestration cut to budget authority for fiscal 2014 will reduce outlays by more than in fiscal year 2013, and outlays will still be falling from fiscal 2013 budget authority cuts lagging into fiscal 2014. Sequestration will eventually level off and cease to be a drag, but Congressional Budget Office (CBO) data show outlay reductions from sequestration rising as a share of GDP through fiscal 2015. When push comes to shove, CBO recently estimated repealing sequestration would boost GDP by 0.7 percent and employment by 900,000 jobs by the end of fiscal 2014. And the reduction in outlays from pre-sequestration cuts will increase as a share of GDP between fiscal 2013 and fiscal 2014, likely reducing growth by an additional 0.2 percentage points.
This outlook is from a baseline of anemic growth rates incapable of spurring recovery – just 1.0 percent annualized GDP growth in the first three quarters of fiscal 2013. Consequently, the labor market, for which economic indicators lag behind GDP growth, is likely to deteriorate by year’s end. This isn’t meant to be hyperbolic prognostication: The three-month rolling average of the employment-to-population-ratio for workers aged 25-54, currently at 75.9 percent in the three months to July 2013, has recovered only one-fifth of its Great Recession plunge and essentially flat-lined over the last year. That’s a better indicator than the monthly jobs reports, which are volatile, and the headline unemployment rate, which has been an exceptionally noisy, misleading economic indicator in recent years.
This outlook may seem hard to square with some economic forecasts predicting real GDP growth accelerating in the fourth quarter of 2013 and throughout 2014, ostensibly driven by a housing market recovery. Residential real estate investment has been boosting recent growth rates, but as economist Dean Baker of the Center for Economic and Policy Research points out, much of the hype about a housing rebound is overly optimistic and out of line with fundamentals; vacancy rates are still quite high by historical standards. A partial rebound in housing is fundamentally incapable of generating a full economic recovery for a demand-depressed economy dragged down by the housing bubble’s implosion.
While the economy does have natural healing mechanisms, the most powerful drivers of economic recovery tend to be monetary and fiscal support—effectively maxed out and pushing in the wrong direction, respectively. Modern forecasting is in somewhat unchartered waters in this context, and forecasts for a year or more out – which should always be taken with a grain of salt – have generally erred on the overly optimistic side since the Federal Reserve’s primary policy rate hit zero and couldn’t be lowered further.
Even if the private sector does pick up, Congress should be helping to build momentum instead of slowing growth—as federal spending cuts are poised to do through 2014. If the private sector pulled real GDP growth closer to 3.0 percent within a year, the economy would still only be making sluggish progress toward full recovery; but if federal fiscal policy swung from subtracting half a percentage point from annualized growth for 2014 to adding that much, the economy would start making rapid progress toward full recovery.
Regrettably, the risk of overly rapid deficit reduction has been lost on far too many U.S. fiscal policymakers. House Majority Leader Eric Cantor (R-VA) didn’t just wrongly claim that federal budget deficit is “growing,” he was wrongly asserting that rising deficits would be “standing in the way of a growing economy.” This nonsensical rejection of textbook economics was, of course, also enshrined in House Budget Committee Chairman Paul Ryan’s (R-WI) fiscal 2014 budget resolution, which proposed accelerating the pace of spending cuts. That budget, passed by the House, would likely have pushed the economy back into recession within the next year if it had been enacted.
To be explicit, blame for decelerating growth and movement away from recovery rests squarely with the GOP. The Left acquiesced to fight for ad hoc deficit-financed job creation measures along with deficit reduction. This needle proved far too difficult to thread. But the Right used unprecedented political obstructionism and every piece of leverage available to extract government spending cuts with no regard for economic reality and zero palpable concern about the timing of those cuts or the headwinds they might create.
A half-sane Congress would heed these lessons as soon as they return from recess and immediately repeal sequestration without offset. And in the current context, there is no credible economic case against incurring public debt to spur economy recovery. But broadly speaking, the Left won the intellectual debate on austerity while losing the policy debate in Washington.
That return to sanity isn’t going to happen. Instead, a full meltdown in governance — again driven by the GOP — is expected, with decent odds of a government shutdown before the end of the year and more budget obstructionism around a necessary increase in the debt ceiling.
The lesson to Congressional Democrats should be clear: Do not concede a penny’s worth of additional spending cuts, and if the far Right wants to shut down the federal government as an umpteenth “vote” against the Affordable Care Act or any other self-destructive act of defiance, the price of reversing that politically untenable position should be cancelling sequestration. A brief government shutdown won’t kill the recovery — the GOP’s austerity has already doing that, and resuscitating the economy realistically requires House Republicans being voted out of the majority.