The federal government looks to be getting out of the business of trying to spur the economy just as the US expansion shows increasing signs of faltering.
A deal struck over the weekend to cut $2.4 trillion or more off budget deficits over a decade marks the beginning of a prolonged effort to put the government’s finances into better shape. While the immediate economic impact from the agreement is likely to be small, it will add to a reduction in growth next year of 1.5 percentage points coming from the expiration of past stimulus programs, according to economists at JPMorgan Chase & Co and Deutsche Bank Securities.
“Over the next 10 years, there will be further spending cuts and higher taxes, and that’s not good for economic growth,” said Paul Dales, senior economist for Capital Economics Ltd in Toronto. “It is the start of a meaningful move toward fiscal consolidation.”
The shift from stimulus to austerity coincides with a slowdown in the two-year recovery. A report last week showed that gross domestic product grew at an annual rate of 1.3 per cent in the second quarter of the year following 0.4 per cent in the first three months, prompting economists to warn of possible relapse into recession.
The economy will suffer another blow next year with the expiration of a temporary two per cent payroll tax cut, an end to extended unemployment benefits and completion of the $830 billion stimulus program that President Barack Obama signed into law more than two years ago. Obama will press Congress to extend a cut in payroll taxes before the end of the year, White House press secretary Jay Carney said yesterday.
‘FISCAL DRAG’
“There is a risk to the recovery that a large amount of fiscal drag is coming at a time when the economy is struggling,” said Peter Hooper, chief economist for Deutsche Bank Securities in New York.
Congressional leaders agreed last weekend on a deal that would cut the federal deficit while raising the nation’s debt ceiling by $2.1 trillion. The pact, which was approved by the House last night and is set to be considered in the Senate on Tuesday, contains $917 billion in cuts, with the balance to come later this year from a special committee of lawmakers.
The debt deal would reduce government outlays by $21 billion in the fiscal year that begins October 1 and by $42 billion in the following year, according to an analysis by the Congressional Budget Office. That pales in comparison with the $15 trillion US economy.
‘SMALL’ IMPACT
The impact of the agreement on the economy next year “is going to be small, maybe a few tenths of a percentage point,” as most of the cuts are put off to the future, said Michael Feroli, chief US economist for JPMorgan in New York.
The turnabout in the long-term budgetary stance also puts pressure on Federal Reserve Chairman Ben S Bernanke and his central bank colleagues to keep monetary policy easier for longer to offset the economic effects from the tighter fiscal outlook.
“The more fiscal drag there is, the less of a case there is for monetary tightening,” said James O’Sullivan, chief economist for MF Global in New York.
He predicts the Fed will keep interest rates at record low near zero and its balance sheet near a record high of $2.87 trillion through this year and into 2012.
Job-creation efforts already have been hampered by cutbacks in the public sector. Since May 2010, total government employment has dropped by 916,000 jobs, according to Labor Department data.
US stock prices bounded ahead in early trading yesterday on news of the budget deal, only to fall back later on fresh signs of economic weakness. The Standard & Poor’s 500 Index ended 0.4 per cent lower at 1,286.94 for a sixth straight daily loss.
