The Sequester: More Opportunity Than Danger

The sequester that took effect Friday will most likely result in cutbacks in certain operations, especially in defense. However, these cuts will be more than offset by an increase in entitlement spending. The budget deficit in 2013 will be smaller in 2013 than in 2012, and that could be a drag on economic growth.

By GENE EPSTEIN
SATURDAY, MARCH 2, 2013
Barron's

Does the sequester that took effect Friday mean the federal government is really downsizing? If Uncle Sam Inc. were a publicly traded stock, Wall Street would probably react to the news with a mixture of scorn and indifference.

There will be cutbacks in certain operations, especially in defense. But the cuts will be more than offset by an increase in entitlement spending. Total outlays will still show a small increase, to a record $3.553 trillion in fiscal year 2013, versus $3.538 trillion in fiscal 2012.

And over the next decade, the sequester will barely make a dent in the Congressional Budget Office's projections that debt as a share of GDP is inexorably climbing toward 200% from its current 76% (see my cover story, "Next Stop, Greece," Feb. 18).

Those who believe in the potency of fiscal policy, however, use different math.

The budget deficit, the difference between revenues and outlays, will be smaller in 2013 than in 2012, and that could be a drag on economic growth. The deficit in 2013 is projected at $845 billion, down from $1.089 trillion in 2012, finally breaking the four-year run of trillion-dollar-plus deficits that began in 2009.

That might sound like progress to some, but it's bad timing to others, given that economic growth is already quite sluggish. As a share of current-dollar gross domestic product, the deficit will decline to 5.3% in 2013 from 7.0% in 2012, a fiscal tightening of 1.7 percentage points that is regarded as worrisome by some.

But when the "fiscal cliff" was looming, the fall in the deficit was projected at 3.3 percentage points, or nearly double the 1.7 points now expected. And even then, historical precedent revealed that even a mild recession might not be imminent (see "Cheer Up! The Cliff Doesn't Look So Grim," Dec. 31). For this 1.7-point decline, the most recent precedent is 1987, when the deficit as a share of gross domestic product fell 1.8 percentage points from the previous year's level. Somewhat perversely from a fiscal-policy point of view, economic growth that year quickened, rather than slowed. On a fourth-quarter-over-fourth-quarter basis, real GDP rose 4.3% in 1987, versus 2.8% in '86.

For two other precedents, in the 1950s, we get mixed results. In 1956, the budget ran a surplus of 0.9% of GDP, a 1.7-point swing from the 0.8% shortfall of the year before. The 1.7-point fiscal drag coincided with a major slowdown in real GDP growth, just as the fiscal policy advocates would have expected. But in 1956, there was also a noticeable hike in the short-term interest rate by the Federal Reserve, which might have been the real factor that slowed economic expansion in that year. In 1954, just as in '87, a 1.4-percentage-point fall in the deficit coincided with a pickup in growth.

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