27 February 2013

The Sequester Explained - Or, How to Shoot Your Cat Out of the Tree

Once upon a time, a cat lover was shocked to learn that his cat had climbed high into a tree. Terrified of what this might mean for the cat's health, he did everything he could to get the cat back onto the ground. He coaxed. He pleaded. He offered tuna. Nothing seemed to work. Eventually, he forgot how all this got started and simply fixated on this: the cat had to come down. So, he finally shot the cat out of the tree.

The deficit was huge. It still is. But the deficit was the lesser of evils in tough economic times. The only option to a larger deficit in a downturn is to raise taxes and / or cut spending when unemployment is already high, when GDP growth is already faltering. Had we cut the deficit to zero last year we'd have to raise taxes and / or cut government spending by $1.3 trillion. That would be about 8 or 9% of GDP. That approach - favored by Eric Cantor and the Tea Party who refused to raise the debt ceiling - is the equivalent of shooting the cat out of the tree because you're nervous about it. The only reason the deficit matters is because it is not sustainable and it could eventually be bad for the economy. To suddenly take 8% of GDP away is not an eventually bad for the economy - it is  an immediately bad for the economy. 

To recap. Big debt - eventually and possibly bad for the economy. Abrupt contraction of economy - immediately and definitely bad. Cat high in the tree - possibly bad. Shooting cat out of the tree - definitely bad.

This will be a slower year for growth because these frequent budget standoffs have worn down the American people who find it increasingly difficult to sustain outrage or interest in congressional deadlock. As the private sector is recovering and growing, the public sector will be further shrinking, and the net effect will be sluggish growth, perhaps even another dip. Unemployment will remain too high. The good news is that the sequester is not quite like shooting your cat out of the tree; it is, instead, just like wounding it. (Cantor's charge to freeze spending, by contrast, would have been like a head shot.)

The right path is to bring down the deficit as the economy improves, but certainly not faster than the economy improves. And it is worth noting that the deficit is currently projected to halve between 2012 and 2014, from $1.3 trillion to $668 billion. [Seen here.] That, it seems to me, is probably faster than is optimal for GDP growth (and for lowering unemployment) over the next couple of years but not bad for longer-term investment markets. This is not a trivial sum, amounting to nearly 4% of GDP in the space of two years, a deficit reduction of $659 billion. To approach the deficit more aggressively is to forget about the health of the cat and get fixated on its place in the tree.

But give the Republicans credit. They know how to work the media. Just as they got everyone fixated on the invasion of Iraq, getting the media and the American people convinced that this was such an urgent task that nothing else mattered - especially questions about "What's next?" - they've now gotten everyone fixated on the deficit and its reduction, as if nothing else matters and convinced people that rapidly reducing the deficit won't bring about a slew of further complications. And there's a sort of evil genius in their approach. To the extent that budget stalemates and government spending cuts and tax hikes make the economy falter, they have further proof that  the economy is in bad shape and we need to take desperate measures. 

It's fine to worry about getting the cat out the tree. Just don't let anyone convince you that this is so important or urgent that you need to reach for a gun. 

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