The Good and Bad of Sequester Cuts

Article excerpt

The markets closely watched the March 1 deadline when the federal government spending cuts of $85 billion in fiscal year 2013 were to take effect as per the Budget Control Act. Often referred to as the "sequester," this event was the first installment of a $1.2-trillion reduction in government spending to be put in place over a period of nine years.

Some analysts have hailed the sequester as a credible budget-reduction program. And that it is. Assuming the entire gamut of spending cuts occurs, the Congressional Budget Office (CBO) estimates that the federal deficit would shrink to $845 billion and $616 billion in fiscal years 2013 and 2014, respectively, from $1.09 trillion in 2012. If these estimates are accurate, the economic ramifications are largely positive. Pressure on interest rates will be reduced as the federal government's participation in credit markets declines.

Yet, a decline in federal-government spending directly reduces real growth, and potential offsets follow with a lag. Assuming a fiscal-spending multiplier at the midpoint of the CBO's stated range, our current estimate of real GDP growth will be reduced 0.5% in 2013 (fourth quarter to fourth quarter) if all provisions of the sequester take effect.

Drilling down to the details of the likely cuts in government spending reveals the micro aspects. A 50% reduction in discretionary defense outlays is baked into the provisions of current law, implying that defense operations will suffer a sizable setback. Reduced funding for schools would translate to fewer teachers and cutbacks in a wide range of programs. Federal-government expenditures related to food inspection, air traffic control, and law enforcement would be pared back. Cuts to border and port security could affect the volume and timing of trade flows. …


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