by Bill McBride on 2/27/2013 11:46:00 AM
Wednesday, February 27, 2013
At this point the biggest downside risk to the US economy is from cutting the deficit too quickly. The deficit is already declining and will continue to decline for the next few years. Additional short term deficit reduction will probably be counter productive (the focus should be on long term deficit reduction, especially health care costs). The "sequester" is bad policy - but it will probably happen anyway. Dumb.
From Brad Plumer at the WaPo Wonkblog: Bernanke: The sequester could make it harder to reduce the deficit, not easier
Federal Reserve Chairman Ben Bernanke had something to say about sequestration during his testimony before the House Banking Committee on Tuesday. He thinks the looming spending cuts could actually make it harder, not easier, to reduce the deficit. Why? They’ll hurt growth:
The CBO estimates that deficit-reduction policies in current law will slow the pace of real GDP growth by about 1-1/2 percentage points this year, relative to what it would have been otherwise.The logic here is simple enough. The sequestration cuts will drag down economic growth this year, which will mean that fewer Americans will have jobs and less tax revenue will pour in. Nothing cures deficits like stronger economic growth. And right now, Congress’s policies are standing in the way of stronger growth.
A significant portion of this effect is related to the automatic spending sequestration that is scheduled to begin on March 1, which, according to the CBO’s estimates, will contribute about 0.6 percentage point to the fiscal drag on economic growth this year. Given the still-moderate underlying pace of economic growth, this additional near-term burden on the recovery is significant.
Moreover, besides having adverse effects on jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run for any given set of fiscal actions.