by Calculated Risk on 1/15/2013 12:38:00 PM

As I noted earlier this year, there are three short term fiscal deadlines this year: 1) the Debt Ceiling, 2) the "sequester", and 3) the “continuing resolution". I'm convinced the debt ceiling will be increased, and something will be worked out on the "sequester", but there is strong possibility the “continuing resolution" will lead to a government shutdown.

Here are some comments from Alec Phillips at Goldman Sachs this morning:

A government shutdown -- modest effects but increasingly likely: Congress opted in September 2012 to extend spending authority for six months, until March 27, 2013. This has been done frequently in recent years when lawmakers cannot agree on full-year spending levels. If spending authority is not extended further, the Obama administration will lose its authority to carry out activities funded by appropriations and will be forced to shut down non-essential government operations. This is not as bad as it sounds, for a few reasons: first, only 40% of federal spending relies on congressional appropriations; the remainder is unaffected by a failure to extend spending authority. Second, about two-thirds of that 40% is deemed "essential" and continues even without a renewal of spending authority. This includes defense functions and services "essential to protect life and property." The upshot is that a one-week shutdown of these activities would reduce federal spending by $8bn to $12bn (annualized). Since a shutdown that begins on March 27 would straddle the end of Q1 and the start of Q2, the effect on quarterly growth is hard to estimate but might be around 0.1pp in each quarter.

As Phillips notes, this will not be catastrophic (like not paying the bills), but it will be disruptive. A "government shutdown" is just a stunt since most of the government expenditures will continue.

Note: Much of the data I rely on is from the Bureau of Labor Statistics (BLS), Census Bureau, and the Bureau of Economy Analysis (BEA) and other agencies that will probably be impacted. This includes the monthly employment report, housing starts, new home sales and much more. This data is very useful, and I think the value far outweighs the cost.

Here is a repeat of what I wrote earlier: Question #1 for 2013: US Fiscal Policy

[T]here are still several fiscal issues remaining for this year. The "sequester" (automatic spending cuts) still needs to be resolved, the "debt ceiling" needs to be raised, and a “continuing resolution” needs to be passed or the government will be shut down.

The so-called "debt ceiling" is really just about paying the bills. Here are a few things to know:
1) The House will raise the debt ceiling before the deadline, and the US will pay the bills.

2) The House majority has no leverage on the "debt ceiling"; as I've noted before, the House majority holds a losing hand and everyone knows it. The sooner they fold (and raise the debt ceiling) the better for everyone. As we saw in 2011, there are real world consequences for waiting until the last minute.

3) Those thinking there are no consequences for missing the deadline, I suggest reading the new (January 7th) Debt Limit Analysis by analysts at the Bipartisan Policy Center. From a political perspective, missing the deadline will, in the words of Republican Senator Mitch McConnell, make the "Republican brand toxic".  It would be political suicide, so it will not happen.

Hopefully the House will fold their losing hand soon. If they are planning on taking the country to the brink, and betting voters will forget like after 2011, I think that is another losing bet.

Although the negotiations on the "sequester" will be tough, I suspect something will be worked out (remember the goal is to limit the amount of austerity in 2013).  The issue that might blow up is the “continuing resolution", and that might mean a partial shut down of the government.  This wouldn't be catastrophic (like the "debt ceiling"), but it would still cause problems for the economy and is a key downside risk.

And a final prediction: If we just stay on the current path - and the "debt ceiling" is raised, and a reasonable agreement is reached on the "sequester", and the “continuing resolution" is passed - I think the deficit will decline faster than most people expect over the next few years.  Eventually the deficit will start to increase again due to rising health care costs (this needs further attention), but that isn't a short term emergency.

Click on graph for larger image.

This graph shows the actual (purple) budget deficit each year as a percent of GDP, and an estimate for the next three years based on current policy (Jan Hatzius at Goldman Sachs estimates the deficit will 3% of GDP in 2015).  Note: With 7.8% unemployment, there is a strong argument for less deficit reduction in the short term, but that doesn't seem to be getting any traction.

As David Wessel at the WSJ recently noted: Putting the Brakes on Cutting the Deficit

In the depths of the most recent recession, the fiscal year that ended Sept. 30, 2009, the deficit was 10.1% of gross domestic product, the value of all the goods and services produced. Since then, the deficit has declined to 9% of GDP in 2010, 8.7% in 2011 and 7.0% in fiscal 2012. Private analysts predict the deficit will be between 5.5% and 6.0% of GDP in fiscal 2013 ...

Over the next few years the deficit will probably be steadily decreasing as a percent of GDP. We don't want to reduce the deficit much faster than this path, because that will be too much of a drag on the economy.

However, later this decade, the deficit will probably start to increase again, mostly due to rising health care expenditures.  Health care spending is a long term issue and needs to be addressed to put the long term debt on a sustainable path long term.

The key points are: the cyclical deficit will slowly decline, and there is a long term issue, mostly related to health care costs that we need to start to address in the next few years.

Final note: I'm convinced the house will fold soon on "paying the bills" (the sooner the better for everyone), but we might see a government shutdown at the end of March.