Because spending cuts to limit debt probably won’t shake the economy

Because spending cuts to limit debt probably wont shake the | ltc-a

The last time the United States came perilously close to defaulting on its debt, a Democratic Speaker and a Republican House Speaker struck a deal to raise the nation’s debt limit and tightly curb the growth of federal spending on years to come. The deal avoided a default, but hampered what was already a slow recovery from the Great Recession.

The debt deal President Biden and President Kevin McCarthy agreed to in principle is less restrictive than the one President Barack Obama and President John Boehner cut in 2011, which focused on just two years of spending cuts and caps. The economy that will absorb those cuts is in much better shape. As a result, economists say the deal is unlikely to inflict the kind of lasting damage to the recovery that the 2011 debt ceiling deal did, and paradoxically, the new spending restraint may even help it.

« For months I have worried about a major economic fallout from the negotiations, but the macro impact appears to be negligible at best, » said Ben Harris, a former Treasury deputy secretary for economic policy who left his post at the beginning of this year.

“The most important impact is the stability that comes with having an agreement,” Harris said. « Markets can function knowing that a cataclysmic debt ceiling crisis is not looming. »

Mr. Biden expressed confidence earlier this month that any deal would not cause an economic downturn. This was in part because growth persisted over the past two years even as pandemic relief spending lapsed and total federal spending fell from high Covid levels, helping to reduce the annual deficit by 1, $7 trillion last year.

Asked at a press conference at the Group of 7 summit in Japan this month whether spending cuts in a budget deal would cause a recession, Mr Biden replied: “I know they won’t. I know they won’t. Indeed, the fact that we managed to cut government spending by $1.7 trillion did not cause a recession. This caused growth.

The agreement in principle has yet to pass the House and Senate, where it is met with opposition from more liberal and conservative members of Congress. It goes far beyond spending limits, including new work requirements for food stamps and other government aid, and an effort to expedite approvals for some energy projects.

But its cornerstone is spending limits. Negotiators agreed on small cuts to discretionary spending — outside of defense and veterans assistance — this year through next, after accounting for some accounting adjustments. Military and veterans spending would increase this year to the amount called for in Biden’s FY 2024 budget. All of these programs would increase 1% in FY 2025, which is less than expected.

An analysis of the proposal by The New York Times suggests it would reduce federal spending by about $55 billion next year, compared to the Congressional Budget Office’s forecast, and another $81 billion in 2025.

The first retrospective analysis of the economic impacts of the deal came from Mark Zandi, an economist at Moody’s Analytics. He had previously estimated that a sustained default could kill seven million jobs in the US economy and that a round of proposed Republican spending cuts would kill 2.6 million jobs.

His analysis of the emerging deal was much more modest: The economy would have 120,000 fewer jobs by the end of 2024 than it would without a deal, he estimates, and the unemployment rate would be about 0 higher. 1%.

Mr. They play he wrote on Twitter on Friday that « it was not the best time for fiscal tightening as the economy is fragile and the risks of recession are high ». But, he said, « it’s manageable. »

Other economists say the economy could actually use a mild dose of fiscal austerity right now. That’s because the biggest economic problem is persistent inflation, which is driven in part by strong consumer spending. Removing some federal spending from the economy could help the Federal Reserve, which has been trying to keep price growth in check by raising interest rates.

« Macroeconomically, this deal is a little help, » said Jason Furman, a Harvard economist who served as deputy director of Obama’s National Economic Council in 2011. rates in bringing about that cooling.

« I think the Fed will welcome the help, » he said.

Economists generally view increased government spending, if not offset by increased tax revenues, as a short-term boost to the economy. That’s because the government borrows money to pay wages, buy equipment, cover health care, and provide other services that ultimately support consumer spending and economic growth. This can especially help lift the economy at times when consumer demand is low, such as in the immediate aftermath of a recession.

That was the case in 2011, when Republicans took control of the House and forced a showdown with Obama over raising the loan limit. The nation was slowly pulling itself out of the hole created by the 2008 financial crisis. The unemployment rate was 9%. The Federal Reserve had cut interest rates to nearly zero to try to stimulate growth, but many liberal economists were calling for the federal government to spend more to support demand and accelerate job growth.

The budget deal between Republicans and Mr. Obama — which was hammered out by Mr. Biden, who was then the vice president — did the opposite. It reduced federal discretionary spending by 4% in the first year after the deal compared to baseline projections. In the second year, it reduced spending by 5.5 percent compared to forecasts.

Many economists have since blamed those cuts, coupled with insufficient stimulus spending at the start of the recession, for prolonging the pain.

The deal announced on Saturday contains minor cuts. But the even bigger difference today is the economic conditions. The unemployment rate is 3.4%. Prices are growing more than 4% a year, well above the Fed’s 2% target rate. Fed officials are trying to cool economic activity by making it more expensive to borrow money.

Michael Feroli, an analyst at JPMorgan Chase, wrote this week that the right way to evaluate the emerging deal was in terms of « how much less work does the Fed have to do to limit aggregate demand because now fiscal tightening is doing that work. » « . Feroli estimated that the deal could work out as the equivalent of a quarter point hike in interest rates, in terms of helping to contain inflation.

While the deal will only modestly affect the nation’s future deficit levels, Republicans have argued it will help the economy by reducing debt accumulation. “We’re trying to bend the government cost curve for the American people,” Rep. Patrick T. McHenry of North Carolina, one of the Republican negotiators, said this week.

However, the spending reductions resulting from the deal will affect discretionary non-advocacy programs, such as Head Start Preschool, and the people they serve. New job demands could choke off food and other assistance for vulnerable Americans.

Many progressive Democrats warned this week that those effects will amount to their own kind of economic damage.

“After inflation eats its share, fixed funding will result in fewer households accessing rental assistance, fewer children in Head Start and fewer services for seniors,” said Lindsay Owens , executive director of the liberal Groundwork Collaborative in Washington.

Catie Edmondson contributed report.