After being delayed for two months, the automatic across-the-board cuts to federal spending — known as sequestration — are set to take effect on Friday.
The self-inflicted negative impact of such a fiscal shock, while not catastrophic, will certainly depress growth, cost jobs and counteract much of the recent progress made on the macro front. In fact, the firm Macroeconomic Advisors LLC estimates the sequester will take 0.6 percent off the already meager 2.6 percent growth forecast for 2013 and cost the nation approximately 700,000 jobs by the end of 2014.
With interest rates at rock-bottom levels, conventional monetary policy doesn’t have the teeth needed to offset the impact of such a sharp fiscal contraction on the broad economy. Economists, by and large, have communicated the self-evident dangers of implementing the sequester at this time.
Ironically, both parties in Congress seem to agree on this. However, the clumsiness with which the deal has been handled is really striking.
The plan is deeply rooted in the narrative of immediate and dire deficit reduction at all costs. And I am still confused about other deficit reduction plans such as Bowles-Simpson that would include tax cuts to achieve a greater fiscal balance. The misstep may have been in accusing increased federal deficits over the last four years of being catalysts of the great recession rather than consequences of it.
Federal deficits increase during recessions for strategic purposes with sound reasoning.
When the U.S. economy contracts, or recovers sluggishly from a deep contraction, there are policies in place known as automatic stabilizers, which are designed to dampen the severity of such a shock to the system. Our progressive income tax policy is one example.
If an individual’s income declines during an economic contraction, as is often the case, they may drop into a lower marginal income tax bracket, thereby paying a lower percentage of income in taxes. As such, government revenue also declines, putting upward pressure on government deficits during these periods.
Government spending on unemployment insurance — think jobless benefits and food stamps — typically increases during tough economic times when people genuinely are in need. As gross domestic product decreases during these times, government expenditures on safety net programs as a share of the total economy increase by way of simple arithmetic. This has been widely misinterpreted as runaway spending. What’s more, federal spending commitments on mandatory programs such as Medicare and Social Security, the key drivers of long-term debt issues, are typically tied to potential growth prospects of our economy. The further we are below what the economy could be producing, given its resources, the greater the share of such expenditures as a percentage of the total pie.
As it turns out, the sequestration will have amplified effects in regions of the nation that rely more heavily on federal spending.
Several studies from Wells Fargo, the Pew Center and USA Today report that Georgia, for instance, derives nearly 7 percent of its GDP from federal spending and, given its relatively large military influence, is slated to lose roughly 17,000 jobs to the sequester. In all, Georgia ranks fifth in states most detrimentally impacted by the cuts.
Even more depressing than the congressional ineptness on display is the fact we have seen this coming for more than a year now.
Dr. Nicholas J. Mangee is an assistant professor of economics at Armstrong Atlantic State University and can be reached at Nicholas.mangee@armstrong.edu.