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Federal budget cuts: Impact and implications

Darrell Spence
Based in:
Los Angeles
Investment experience:

DARRELL SPENCE: The sequester itself — the headline dollar amount of $85 billion [of the ultimate $1.2 trillion total] — is about 0.6% of GDP. However, not all of that is likely to actually be implemented in the current year. The payroll tax hike that occurred at the beginning of the year was about another $100–105 billion, so about 0.7% of GDP. So you can see how, when you start to add these things up, you’re starting to exert a reasonable drag on U.S. economic activity.

The good news is that the private sector seems to be doing pretty well. The housing market is recovering, and you have very strong construction activity going on; nonresidential construction is starting to do the same thing. Big-ticket purchases like autos have been increasing for a number of years now. Businesses are starting to invest, because they have reasonable profit growth and high profit margins and rising utilization rates.

So there’s a whole host of other things that are going on within the U.S. economy that can offset the drag that’s coming from fiscal policy. And when you start to add up all of the dollars, net-net, that keeps the economy growing — granted, perhaps not as fast as we’ve become accustomed to, particularly coming out of difficult economic periods. But I don’t think the sequester is enough to drag the economy down into a recession, given all of the other things that are going on in the private sector that are much more positive.

I think the Federal Reserve views the sequester as yet another drag on growth. They’ve made it very clear that they are unlikely to change the stance of their policy until they find a good reason to do so, and that good reason is going to be a better growth outlook. They pretty much explicitly laid out that they won’t start to raise interest rates until the unemployment rate gets down closer to 6.5%. Now, there are other ways that they could start to remove accommodation, or even tighten policy, that have to do with the balance sheet measures and all of the assets that they’ve purchased. But again, I think their comments have been pretty clear: They don’t view the economy as growing strongly enough to start removing some of that accommodation. And they’re going to view the sequester as just yet another reason to keep the accommodation in place.

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