Just as people were starting to relax – feeling that the warnings had been too alarmist – the “sequester” news took a turn for the worse.
The consequences go beyond confirming that an already sluggish U.S. economy will now face a fiscal drag of ½% of GDP this year (the first year of the sequester), adding to the 1% of GDP drag in the end-of-year “fiscal cliff” deal. They also suggest that we may never get a full handle on the negative effects of Congress’s self-inflicted wound.
The sequester, or the automatic set of blunt spending cuts triggered by Congressional polarization and dysfunction, was all over the news in the first few weeks of the year. Warnings got louder as we got closer to the trigger date. Yet, in the immediate aftermath of the trigger, the vast majority of Americans felt no effects.
Many blamed the press for overhyping the issue. Some even pounced on the “false alarm” as confirmation that budget cuts, no matter how badly designed, could and should be pursued without hesitation. Just a few brave souls warned that it was only a matter of time until the adverse effects would become clearer.
I experienced a small reminder starting on Saturday evening. The airline I was flying the next morning sent me an automated e-mail warning me that “as a result of recent Federal Aviation Administration (FAA) sequestration budget cuts, your flight may experience delays.”
On the plane the next day, the pilot informed us 20 minutes from our scheduled landing time that we had been placed on a “sequester hold.” After we circled for quite a while, we were cleared to land.
On arrival at the terminal, I glanced at the screens. Despite good weather, most incoming and outgoing flights were quite delayed. Then I received an automated e-mail from another airline. This one warned me that “due to FAA furloughs, airport and flight delays are possible.”
The next morning Libby Cantrill, a PIMCO colleague who follows the issue closely, confirmed that “sequester-related furloughs begin this week” across a number of federal agencies. Moreover, while problems were likely, she wrote that “they are not anticipated to catalyze members on the Hill to mitigate the sequester cuts for 2013.”
Most analysts agree on the sequester’s measurable fiscal contraction. But what I realised as the subject was discussed during my meetings on the road is that the indirect effects, while consequential, may be largely invisible to most. So here are four of many:
- With fiscal policy now stepping on the economic brakes, monetary policy is having to step even more on the accelerator. This contributes to an even greater imbalance in the economic policy mix, puts greater pressure on highly experimental Fed measures, and increases the risk of collateral damage and unintended consequences. (see here for additional information)
- Companies and individuals will be tempted to alter travel plans. Remember, no one like delays. They are stressful, mess up schedules, and cause major coordination headaches. The louder the news about potential flight delays, the greater the likelihood of people cancelling trips, with adverse implications for hotel stays, rental cars and many other travel-related activities.
- More broadly, the reality of the sequester will undermine consumer and corporate confidence. This again translates into foregone economic activity. It also influences negatively expectations about future growth and job creation.
- All this will act as a catalyst for louder political blame games, and do so at a particularly unfortunate time. With the November 2012 elections behind us, many had hoped for more constructive political interactions and, perhaps, even some breakthroughs in the coming months. If this window is not properly exploited, it will be closed by the growing proximity of the 2014 Congressional elections.
Unfortunately, none of these effects – and, more importantly, their joint impact – is subject to precise quantification. As such, some may be tempted to dismiss them as inconsequential. That would be a mistake.
Any avoidable headwind to growth – and this one is self-manufactured by Congress – is a travesty for an economy that is already struggling to grow by 2% a year, has an unemployment rate of 7.6% (with some 40% composed of long-term joblessness), has seen its labour participation rate fall to a level last seen in 1979, and still needs to de-leverage safely over time. It is not too late for Congress to course correct. And it can do so in two ways: Invert the fiscal policy logic, and supplement budgetary reforms with growth enhancers.
Today, Congress is combining blunt short-term contraction with pronounced longer-term uncertainty. This is a horrid mix; and it makes no economic sense. A more sensible approach would be to agree on medium-term fiscal reforms (for both revenues and spending) and lighten on immediate sequester-related cuts.
The inappropriate fiscal stance is not the only element holding back growth and jobs. Congress could also improve economic prospects by addressing structural impediments to the proper functioning of the labour market, credit, and infrastructure.
America is not Europe: The country does not face huge economic engineering problems in designing and implementing inclusive growth-enhancing policies. It faces political dysfunction that a set of well-intentioned politicians can (and need to) fix.
Unlike my Sunday flight that was forced into a circling pattern, there is no good reason to subject endogenous political renewal to an endless “hold.”
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