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Sequester's Economic Impact Will Build Slowly Sequester's Economic Impact Will Build Slowly

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Sequester's Economic Impact Will Build Slowly

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The economic impact of the sequester will not be felt immediately. (iStock)()

Do no harm. That’s the best prescription for the economy that a divided Congress and administration can offer right now.

As the automatic cuts known as the sequester go into effect on Friday, the two parties cannot agree on any solution to undo the reductions that were first agreed to in the summer of 2011, when most people assumed Congress would take action to head them off. Nor is there any likelihood of a bipartisan deal on extra government spending for job creation, infrastructure projects, or manufacturing initiatives. So, with the economy slowly recovering and the national unemployment rate dropping, the best the federal government can offer is to get out of the way, and let the economy pick itself up.

 

How will sequestration impact the economy? Many experts say the economy will improve if the political stalemate does not leave the sequester cuts in place indefinitely, cause a government shutdown, or lead to a default on the debt ceiling early this summer.

Already, there are signs for economic optimism separate from Washington’s ongoing fiscal wars. The Dow Jones industrial average closed at a level on Wednesday not seen since 2007. This, despite the threats of the across-the-board cuts slated to begin Friday. Real-estate prices rose 7.3 percent in 2012, according to data released this week from the Standard & Poor’s Case-Shiller housing index.

This decent economic news “will help to spur a virtuous cycle of faster growth in employment, income, consumer spending, and business investment over the next few years,” the Congressional Budget Office wrote in its annual outlook, published in early February. (The unemployment rate still remains a sore point, estimated to remain above 7 percent through 2014).

 

This constellation of better-than-we've-seen-lately data should give Americans hope that the economy will improve over the next decade. The biggest threats now are the potential actions of the federal government and the way lawmakers react to the upcoming series of mini-cliffs. Or, as two Goldman Sachs economists characterized it: 2013 will be the year of the growing economy versus Washington’s haphazard fiscal policies.

Take the sequester cuts. Most economists agree that the sequester will not cause a catastrophe for the country’s economic outlook. Yes, the across-the-board spending cuts will lead to hundreds of thousands of job losses and a fiscal drag of 0.6 percent for 2013, according to the forecasting firm of Macroeconomic Advisers. Mostly, though, the rub is the timing and the inartful nature of the cuts.

“It would clearly be preferable to have a more orderly process for fiscal adjustment than the indiscriminate effects of sequestration,” wrote Macroeconomic Advisers in a recent research note.

The inopportune moment of sequestration — hitting just as the economy shows bright spots — will create a drag on the economy in a slow-motion manner. First, the furlough notices will go out in March to federal employees, the majority of whom live outside of the Washington metro area. Unemployment checks will drop as early as April for the long-term unemployed who receive the federal benefit checks.

 

States eventually will have to decide how to cut programs for low-income or vulnerable people that are funded through federal grants, such as child-care assistance, nutrition programs for women and children, mental-health services, and meal programs for senior citizens.

If Congress keeps the sequester cuts in place for a few months, then the economy will start to feel the effects. Federal workers furloughed for as many as 22 days between mid-April, when the furloughs are expected to begin to occur, and the end of the fiscal year will face a pay cut of as much as 20 percent. This will have ripple effects throughout the economy on consumer spending as well as state income and sales taxes.

By July, August, and September, the impact of sequestration should be fully felt. “We’re not going to go into a downward spiral overnight, but the spending cuts will build, and as they build, the effects will become noticeable,” says Nigel Gault, the chief U.S. economist of IHS Global Insight.

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Already, the economic data showed a dip in federal-government spending for defense in the first quarter, a reaction to the impending cuts.

That is the real takeaway of the sequester and its economic impact. It will not hurt the economy immediately, but it still serves as a reminder of the power the federal government holds over the economy. Even if the government cannot enact policies to boost growth, it certainly can hurt the long-term prospects.

The stock market and business leaders are not reacting strongly to the sequester cuts because, for now, this fiscal battle is following a predictable path of brinkmanship, political messaging, and ultimately, resolution. The economy will continue its upward trajectory as long as Washington sticks to this route and does no harm. That means Washington will have to end its fighting, even if it does not address the long-term budget issues such as healthcare spending that is expected to rise drastically by the end of the decade.

“With each passing round of brinkmanship, it becomes less worrisome,” said Mark Zandi, the chief economist for Moody’s Analytics. “Everyone knows the script.”

This article appears in the March 1, 2013 edition of NJ Daily.

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