My views on the $85 billion meat cleaver of federal spending cuts, also known as the “sequester,” are entirely predictable to anyone who knows me or has been reading this blog. I think it’s a dumb thing to do when the economy is still weak and needs more deficit spending rather than less, it’s bad public policy to make indiscriminate cuts instead of selective cuts, and it’s not surprising that Congressional Republicans chose sequester over a balanced package of spending cuts and tax increases. I didn’t blog about it earlier because I didn’t want to be too predictable.
What’s interesting to me is that the sequester is nothing new in a sense. We had the opposite policy for two years, in the form of the 2009-2010 stimulus package, which pumped about $394 billion per year in new federal spending into the economy, and then the federal stimulus went down to about $0. The original yearly amount was about 2.5% of GDP, which should have boosted the economy quite a bit. Many leading estimates are that it did. The Commerce Department’s Bureau of Economic Analysis breaks down the contribution to GDP growth of the different components (household consumption, business investment, government purchases, net exports). Their estimates are that the federal government’s contribution to economic growth was just 0.74 percentage points in 2009 and a minuscule 0.14 points in 2010. (In both years, consumption and investment accounted for most of the change in GDP.) Possibly those numbers are underestimates and they probably do not account for any “multiplier” effects on consumption (people get money from the government and go out and spend it, etc.), but what I want to focus on is the next year, 2011, when the stimulus basically ran out.
In 2011, the combined federal, state, and local government contribution to real GDP growth was -0.67 points (which looks kind of small to me considering that stimulus spending fell by about $300 to $400 billion). It wasn’t much better — -0.34 points — in 2012. A problem with fiscal stimulus is that it’s temporary — if the patient doesn’t respond immediately, Dr. Congress decides that the medicine doesn’t work or is too expensive.
The sequestration amount for 2013 is $85 billion, or roughly 0.5% of GDP. Economists’ estimates of the size of the multiplier vary, from below 1 to about 1.4, so the likely reduction in GDP would be in the range of 0.3% to 0.7%. This would definitely hurt, but keep in mind that the government was tightening its fiscal policy in 2011 and 2012, too, with negative impacts of about the same size. To further play devil’s advocate, while the sequester is bad news and bad public policy, it’s unlikely to push the economy into recession, not if consumption and investment continue to grow as fast as they did over the past three years (with an average combined contribution to growth of about 2.5 percentage points). It’s still a lousy time to cut spending and raise taxes, but in the aggregate these cuts are mild enough that they’re merely misguided, not catastrophic.