We Have A Debt-Ceiling Deal. The Economy Loses.

Earlier this week the absurd and totally unnecessary debate in Washington over raising the national debt-ceiling came to an agreement, both houses of Congress passed it, and the President signed it.  Earlier this week I gave this metaphor for the deal, wondering why we need enemies with “friends” like our representatives in Washington.  Now that I’ve had a little more time to reflect, read some more on the details, comment on radio & TV about it, I think I was too easy on it.  It’s worse than it first appears.

This deal doesn’t “guarantee” that the U.S. government will reduce it’s deficit and maintain “solvency” (a non-concept for a sovereign country with a central bank).  Instead, this deal is more likely to guarantee that our economic non-recovery does, indeed, become at least a lost decade, if not a depression.  Right now I want to look at the economic impact of the deal.  In another post I’ll look at another casualty of the deal and the probably political-economy impact.

So what does the deal do specifically?  Well the details are fairly complex, even by Washington standards.  Right now the debt ceiling rises by $400 billion – enough to last for probably 3-4 months.  No real cuts will happen for maybe 60 more days.  Then starting in October 2011, which is the start of the government’s fiscal year 2012 budget (see here for definition of fiscal year), the action begins. Caps on spending start.  There are no tax or revenue changes in the deal.  It starts modestly with only $21 billion in spending cuts in 2012, although many of those cuts will be felt painfully by many citizens.  Students in graduate school in particular will feel the pinch in their pocket. Then in the remaining 9 years of the deal, there will be at least another $896 billion in reduced spending, amounting to about $100 billion less spending per year than currently planned.

This total of $917 billion in reduced spending is only the start though.  Congress is going to appoint a “special joint committee” of 12 members to recommend and additional $1.2-1.5 trillion in either spending cuts or tax revenue increases over the next 10 years.  (if you believe that committee with half Republicans will allow any revenue increases, I have a bridge in Brooklyn for sale).  If Congress doesn’t adopt those cuts, then Medicare payments, defense spending, and other discretionary spending would automatically by cut across the board. Either way spending gets cut another $1.2 trillion for the years 2013-2022.

This deal is supposed to raise the debt ceiling enough to get us through the end  of 2012 and the presidential election before the debt ceiling has to be raised again, sparing us this debate.  Don’t bet the your house on that though because House Republicans are betting they can keep this debate alive through then.  Basically Congress has created an elaborate mechanism in this law that increases the debt ceiling in several steps between now and the end of 2012.  But the way it’s done is that the debt ceiling keeps going up unless Congress votes to stop it (which the President would then veto).  It’s  a way for Republicans to keep talking about the debt and deficit, to keep recording “votes” against it, but all the time knowing that the debt ceiling will rise because it has to.  Pure politics at the expense of the country.

Right now the economy has over 9% unemployment.  Inflation is so low that deflation is actually the threat. The economy has effectively stalled or at least reached “stall speed”, threatening another double-dip recession.  This is not the time to be cutting spending.  To the degree spending cuts are necessary, they should happen when the economy is at or nearing full employment, not now.  At this time the economy needs all the spending it can find whether it’s from consumers, firms, or government.  And right now, firms and consumers are pulling back and keeping their wallets closed.  The government needs to step up and fill the gap.

So bottom-line, what should we expect?  I’ve seen several estimates from folks with more sophisticated econometric models than I can access.  My own back-of-the-envelope calculations and intuition say the drag on the economy is significant.  In 2012, this deal is probably going to take up to another 0.4 percentage points off of GDP growth.  The real damage starts in 2013 with a reduction closer to 1%.  Remember we’ve only grown at 0.8% rate so far in the first half of 2011, so 2012 will be close to zero growth and 2013 will likely be negative unless some other source of growth and spending can be found.  Looking around, it’s hard to imagine where that could be.  Instead I see nothing but possible negative risks: Europe imploding in a currency and austerity crisis, China having to pull back to slow their inflation, the housing mess in the U.S. is still bad, U.S. banks aren’t as healthy as they claim.

The estimates I’ve seen are similar.  Economic Policy Institute says the debt ceiling deal with cost us 1.8 million jobs in 2012 alone. The same article reports:

Top economists and CEO’s have also weighed in against the deal and said that GOP concessions to the Tea Party will cost our economy dearly. Pimco CEO Mohamed El-Erian warned that the deal will lead to less growth, more unemployment, and more inequality. Nobel Prize-winning economist Paul Krugman called the plan “a disaster” and “an abject surrender” that will “depress the economy even further.”

The Center for American Progress’s Michael Ettlinger and Michael Linden argue that while the deal “goes straight in the wrong direction,” Congress can redeem itself by using the so-called “super committee” mandated by the bill to focus on job creation. The committee, made up of six Republicans and six Democrats, is tasked with finding an additional $1.5 trillion of deficit reduction over the next 10 years, and must report a plan by Thanksgiving.

It’s noteworthy that J.P.Morgan Chase Bank’s research department, as representative of Wall Street as any, says that overall with this deal, government budget policy in 2012 subtract at least 1.5% points from GDP growth rate in 2012.  Since  it takes at least 2% growth in GDP to keep unemployment stable and we haven’t even had a single quarter of growth at more than a 4% rate since the end of 2006, things look grim for employment.

The cutters and austerians have won.  They will make a wasteland of the economy in the name of fighting the deficit.

3 thoughts on “We Have A Debt-Ceiling Deal. The Economy Loses.

  1. Here is another question, Jim: How rate of inflation correlates with rate of GDP? Let’s say if country GDP is 4% and the inflation per same period is 3%, does it mean that real GDP would be 1% only?
    Thank you.

    • Yes, there is a relationship (definition) between nominal GDP (what we observe and measure), inflation, and real GDP. Real GDP is what we really want to know. It’s an estimate of the growth of actual stuff of quantities of stuff and services. Nominal GDP captures increased quantities, but it also captures increased prices. So yes, in simple terms, if nominal GDP grows at say 4% and inflation is 3%, then real GDP increased 1%. Most GDP numbers reported or used by economists are real GDP numbers, although some don’t always.

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