Sequestration, or the across-the-board cuts to discretionary spending that are programmed to automatically kick in on March 1 if Congress and President Obama don't agree on how to avoid the cuts, will create significant head winds for growth through next year, according to Macroeconomic Advisers, LLC.
The St. Louis-based economic analysis firm estimates that unemployment will shrink from the current 7.90 percent to 7.4 percent by the end of 2014, but the automatic budget cuts (as they stand now) would shave a quarter percent off that growth as government spending -- including for private sector contracts and military personnel -- would be curtailed. That could translate to 700,000 jobs lost (including reductions in the armed forces) and the possibility that higher unemployment "would linger for several years," according to the report.
The cuts would also likely cause a 0.6 percent reduction in total gross domestic product (GDP) growth this year to 2 percent. The largest impact, according to the report, would be in the second quarter. If the forecast turns out to be accurate, sequestration could push GDP growth lower than it was last year when it was 2.2 percent, according to the Bureau of Economic Analysis.
“The macroeconomic impact of the sequestration is not catastrophic,” said the forecast, which was published on Tuesday. “Nevertheless, the indiscriminate fiscal restraint would come on the heels of tax increases in the first quarter that total nearly $200 billion, with the economy still struggling to overcome the legacy of the Great Recession.”
But slower economic growth could force the Fed to keep interest rates lower for a longer period of time, in which case GDP growth in 2014 could be supported slightly by the effects of sequestration.
The study suggests that a preferable policy would be to implement a long-term deficit reduction plan that combined revenue increases through tax hikes and more carefully considered cuts to discretionary spending. It also suggests fundamental reform to entitlement programs.
The U.S. hit its debt ceiling on Dec. 31. The Treasury has implemented temporary policies to continue paying its bills. On March 1, Congress and the White House must either raise the debt ceiling or adopt some other strategy involving a reduction to spending and an increase in revenue or else the government risks defaulting on some of its financial commitments. While a sovereign debt default is unlikely, the U.S. government could default on private sector contracts unless something is done.
On Tuesday, President Obama warned that unless Republicans come up with an alternative plan, sequestration would result in job losses. Meanwhile, Erksine Bowles, who was a chief of staff under President Bill Clinton, and former Wyoming Republican Sen. Alan Simpson unveiled their latest plan to cut the deficit by $2.4 trillion over the next decade.
But Bowles said Congress isn’t likely to get anything of consequence done in the next eight days to avert sequestration -- at least not until Americans and lawmakers themselves begin to feel the effects of the cuts.
"When you guys have to go out here to Reagan Airport [in Washington D.C.] and you have to wait three hours to go through airport security, you are going to be pissed, and so is everyone else," Bowles said, according to CBS News, referring to the steep cuts expected to hit airline security services provided by the Transportation Security Administration, among other government agencies.