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US: Why spending cuts probably won’t shake the economy

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The last time the United States came close to defaulting on its debt, a Democratic president and a Republican House of Representatives spokesman reached an agreement to raise the nation’s debt limit and strictly limit the growth of federal spending on next years.

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The deal prevented a default but hampered what was already a slow recovery from the Great Recession.

The United States House of Representatives and Capitol dome on May 28, 2023 in Washington, DC.  Biden and the GOP have reached an agreement to raise the debt limit and avoid default for two years.  Anna Rose Layden/Getty Images/AFP (Photo by Anna Rose Layden/GETTY IMAGES NORTH AMERICA/Getty Images via AFP)

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The United States House of Representatives and Capitol dome on May 28, 2023 in Washington, DC. Biden and the GOP have reached an agreement to raise the debt limit and avoid default for two years. Anna Rose Layden/Getty Images/AFP (Photo by Anna Rose Layden/GETTY IMAGES NORTH AMERICA/Getty Images via AFP)

The debt deal that President Biden and House Speaker Kevin McCarthy agreed to in principle is less restrictive than what the president Barack Obama and the Speaker of the House of Representatives, John Boehnerthey achieved in 2011, 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 fresh contraction in spending could also help her.

“For months I have worried about the economic consequences of the negotiations, but the macroeconomic impact appears to be negligible at best,” he said. Ben Harrisformer undersecretary of the Treasury for economic policy who left his post earlier this year.

“The biggest impact is the stability that comes with an agreement,” Harris said.

“Markets can function knowing a cataclysmic debt ceiling crisis isn’t coming.”

Biden expressed confidence earlier this month that any deal would not trigger an economic downturn.

This was in part because growth has persisted over the past two years, even as pandemic relief spending has lapsed and total federal spending has fallen from high Covid levels, helping to reduce the annual deficit by 1 .7 trillion dollars 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, Biden replied:

“I know they won’t. I know they won’t. In fact, the fact that we were able to cut government spending by $1.7 trillion didn’t cause a recession. It caused growth.”

In principle, the deal still needs to be approved by the House of Representatives and the Senate, where it faces opposition from more liberal and conservative members of Congress.

It goes well beyond spending limits, as it also includes new work requirements for food stamps and other government aid, and an effort to expedite permits for some energy projects.

But its core is the spending limitation.

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 grow 1% in fiscal 2025, less than expected.

An analysis of the proposal by the New York Times suggests it would reduce federal spending for about 55,000 million dollars next year, over the Congressional Budget Office’s forecast, and another $81 billion in 2025.

Mark Zandi, economist at Moody’s Analytics, conducted the first analysis of the economic implications of the agreement. Zandi had already calculated that it could end in a prolonged default seven million jobs in the US economy, and that a deep round of Republican-proposed spending cuts would kill 2.6 million jobs.

His analysis of the fledgling deal was far 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 0.1 percent higher.

Zandi tweeted on Friday that “this is not the best time for fiscal tightening as the economy is fragile and recession risks are high.”

But, he said, “it is manageable“.

Corrective

Other economists say the economy could actually use a light dose of fiscal austerity Right now.

That’s because the biggest economic problem is persistent inflation, driven in part by strong consumer spending.

Removing some federal spending from the economy could help the Federal Reserve, which has been trying to control the price growth raising interest rates.

“Macroeconomically, this deal is a bit of a help,” said Jason Furman, a Harvard economist who served as deputy director of Obama’s National Economic Council in 2011.

“The economy has yet to cool, and that takes the pressure off interest rates to get that cooling.”

“I think the Fed will appreciate the help,” he said.

Economists typically view increased government spending — if not accompanied by an increase in 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 help lift the economy at times when consumer demand is low, such as right after a recession.

That was the case in 2011, when Republicans took control of the House of Representatives and forced a showdown with Obama for raising the debt limit.

The nation was slowly pulling itself out of the hole created by the 2008 financial crisis. The unemployment rate was 9%.

Transition

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 help stimulate demand and accelerate job growth.

The budget deal between the Republicans and Obama — which was brokered by Biden, then the vice president — did the opposite.

Federal discretionary spending was reduced by 4% in the first year after the deal compared to baseline projections.

In the second year, it reduced spending by 5.5% compared to forecasts.

Since then, many economists have blamed those cuts, coupled with insufficient stimulus spending at the start of the recession, of prolonging the suffering.

The deal announced on Saturday contains minor cuts.

But the biggest difference today is the economic conditions. The unemployment rate is 3.4%.

Prices are growing more than 4% annually, well above the 2% target set by the Federal Reserve.

Federal Reserve officials are trying to cool economic activity by making loans more expensive.

Michael Feroli, analyst at JPMorgan Chasehe wrote this week that the correct way to evaluate the emerging deal was in terms of “how much less work the Fed has to do to tighten aggregate demand because tax belt tightening is now doing that work.”

Feroli estimated that the deal could work as the equivalent of a quarter point hike in interest rates, in terms of helping to contain inflation.

Although 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 to the American people,” Rep. Patrick T. McHenry of North Carolina, one of the Republican negotiators, said this week.

However, the spending reductions in the deal will affect discretionary non-defense programs, such as Head Start Preschool, and the people they serve.

The new work requirements could cut back on food and other relief supplies to vulnerable Americans.

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

“After inflation eats its share, fixed funding will mean fewer households with access to rent assistance, fewer children benefiting and fewer services for seniors,” said Lindsay Owens, the organization’s executive director. Liberal Groundwork Collaborative in Washington.

Catie Edmondson contributed to this article.

c.2023 The New York Times Society

Source: Clarin

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