The Consequences of Sequestration

budget signWith Congress once again unable to reach any type of deal, it appears as though the US was able to vault the fiscal cliff only to fall right back into the pit of sequestration. This threat of the budget sequester—in other words, automatic, across-the-board cuts in funding—is soon to become a painful reality that would significantly hamper US economic growth.

The cuts were born of the epic 2011 fight over the debt ceiling. The idea was to create a “trigger” so onerous and indiscriminate that both parties would have an incentive to devise a smarter way to reduce deficits. Instead, the bipartisan committee was unable to reach an agreement and now Congress is faced with the undesirable but increasingly likely prospect of sequestration. This would mean $109 billion in automatic spending cuts, with defense spending being cut by 13 percent. The sequester would also lead to a short term contraction in GDP, since government spending is a component of GDP calculation. This contraction in growth would be compounded by Federal Reserve policy. For example, IMF research suggests that under current conditions, with slack in the economy and the central bank’s policy rate close to zero, the multiplier on government spending may be higher than normal. Moreover, the substantial cuts in spending would force the federal government to decrease pay and lay off government employees, an event that is highly adverse to both US economy and morale.

All this could be avoided if Republicans and Democrats can concede on issues closest to them. For Republicans, that would be tax increases, whereas for Democrats, that would be entitlement spending. Despite both sides wanting to avoid the sequester, it seems that Republicans and Democrats are unwavering in their stubbornness and it is becoming less and less likely that a deal will be struck before the March 1st deadline. It is a testament to the ineptitude of the Congress if they allow the sequester to inflict economic harm that could have been circumvented through logic and compromise. Instead, it remains to be seen whether the sequester will take effect or if another down to the wire political spectacle awaits.

Posted by: Matthew Goldberg

Sources: Economist, CNN Money, Forbes

Photo Credit: budget courtesy of flickr user 401(K) 2013

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