March 2013 is coming to a Close: Will we survive
the Sequester?
“This is not going to be an apocalypse, I
think as some people have said.” Those were the words of President Obama to
journalists just before he authorized $85 billion in the form of automatic
federal spending cuts through sequestration. With a single stroke of the pen,
Obama was taking a completely different path from what the White House had been
singing for months. If there was ever any lesson from Obama’s statement, it is
that Americans could still survive the automatic cuts.
Congress passed the Budget Control Act (BCA)
in 2011 with the primary purpose of imposing caps aimed at reducing
discretionary spending by over $1 trillion through the following decade
beginning 2012.The legislation also established the Joint Select Committee on
Deficit Reduction (the Super Committee). The Committee was to reduce the deficit
by another $1.2 trillion with a provision that across the board automatic
spending cuts would apply from January in the event that the committee fails. Congress
had some agreement in January on taxes but it was unable to come up with a
replacement of the sequester.
It would be dishonest to downplay the
potential negative impacts of the sequester. For one, defense spending which is
one of the areas scheduled for cuts is an important sector of the economy. With
close to 8% cut on defense spending, many businesses and families that are
directly connected to defense spending will be hurt. Top in that list would be
those businesses that rely on defense contracts. Cuts in the various social
safety net programs will also have a significant impact on the economy. Thousands
of federal employees are also going to face layoffs .Some of these employees
will also have to take more days of unpaid offs per week.
The economy is just coming from a troubling
recession and the recovery process may take quite some time. Aggregate demand,
which is important for that recovery, is still not very encouraging. The
automatic spending cuts will surely dampen aggregate demand. Monetary policy
may have been helpful in compensating for the contractions in fiscal policy
measures. The impact of monetary policy measures may, however, be negligible
given that the Federal Reserve has continued to keep the funds rate very low. The current policy stance as announced by the
Fed in many occasions is to keep the rate near zero until some time in 2014.
In theory, a lower Federal funds rate should
increase liquidity in the economy. There are, however, some other conditions
that must exist for this to be a reality. Lower costs of capital are only
useful if lenders have confidence in the securities deposited by the borrowers.
Lenders consider government securities as the safest. A reduction of government
participation in the borrowing market in the manner envisaged by the automatic
spending cuts is in stark contrast to this reality. The Fed may as well be
engaging in a futile exercise if the near zero funds rate cannot stimulate
liquidity.
Even with the above negative consequences,
not all is lost.
For one, the cuts were never across the board
as has largely been reported in popular media. Several program exemptions in
the sequester will lessen its consequences. Most of the exempt programs are
mandatory expenditures. They include Social Security, Medicaid and refundable
tax credits to individuals. Others are low income programs such as health
insurance to children, Supplemental Nutrition Assistance Program. Discretionary
programs exempted include all programs that are under the administration of
Veteran Affairs. The President can also notify the Congress for the exemption
of military personnel accounts. These exempt programs can still have an
important role in the process of recovery.
It is not that government spending will be
reducing over time.
For months, the White House had created the
impression that the sequester would lead to a government shutdown. This
attitude may be in line with the original idea of extending the automatic cuts
in the first place. It was meant to put a gun on the head of the politicians to
force them to come up with a sustainable fiscal solution. It could be that the
gun may as well be firing blanks. Both Democrats and Republicans are still
stuck to their respective party positions. The fact of the matter is that
government spending will actually be increasing over time. The sequester
defines reduction in terms of percentages making it possible that nominal
spending will actually increase over the decade in which it is to be in place.
Public opinion to the automatic cuts
corroborates the view that it may not be a priority in the minds of many
Americans. Perhaps this indifference is a result of citizen fatigue owing to
the inability of the politicians to seek real solutions. One thing we can be
sure of is that we will survive the sequester.
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