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Explained: Why spending cuts may not shake the economy of United States

The deal averted default, but it hindered what was already a slow recovery from the Great Recession

US President Joe Biden

US President Joe Biden

Bloomberg
The last time the United States came perilously close to defaulting on its debt, a Democratic president and a Republican speaker of the House cut a deal to raise the nation’s borrowing limit and tightly restrain some federal spending growth for years to come. The deal averted default, but it hindered what was already a slow recovery from the Great Recession.
 
The debt deal that President Joe Biden and Speaker Kevin McCarthy have agreed to in principle is less restrictive than the one President Barack Obama and Speaker John Boehner cut in 2011, centred on just two years of cuts and caps in spending. The economy that will absorb those cuts is in much better shape. As a result, economists say the agreement is unlikely to inflict the sort of lasting damage to the recovery that was caused by the 2011 debt ceiling deal — and, paradoxically, the newfound spending restraint might even help it.
 
“For months, I had worried about a major economic fallout from the negotiations, but the macro impact appears to be negligible at best,” said Ben Harris, a former deputy Treasury secretary for economic policy who left his post earlier this year.
“The most important impact is the stability that comes with having a deal,” Harris said. “Markets can function knowing that we don’t have a cataclysmic debt ceiling crisis looming.”
 
Biden expressed confidence earlier this month that any deal would not spark an economic downturn. That was in part because growth persisted over the past two years even as pandemic aid spending expired and total federal spending fell from elevated Covid levels, helping to reduce the annual deficit by $1.7 trillion last year.
 
Asked at a news conference at the Group of 7 summit in Japan this month if spending cuts in a budget deal would cause a recession, Mr. Biden replied: “I know they won’t. I know they won’t. Matter of fact, the fact that we were able to cut government spending by $1.7 trillion, that didn’t cause a recession. That caused growth.”
 

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The agreement in principle still must pass the House and Senate, where it is facing opposition from the most liberal and conservative members of Congress. It goes well beyond spending limits, also including new work requirements for food stamps and other government aid and an effort to speed permitting for some energy projects.
 
A New York Times analysis of the proposal suggests it would reduce federal spending by about $55 billion next year, compared with Congressional Budget Office forecasts, and by another $81 billion in 2025.
 
The first back-of-the-envelope analysis of the deal’s economic impacts came from Mark Zandi, a Moody’s Analytics economist. He had previously estimated that a prolonged default could kill seven million jobs in the U.S. economy — and that a deep round of proposed Republican spending cuts would kill 2.6 million jobs.
 
His analysis of the emerging deal was far more modest: The economy would have 120,000 fewer jobs by the end of 2024 than it would without a deal, he estimates, and the unemployment rate would be about 0.1 per cent higher.
Zandi wrote on Twitter on Friday that it was “Not the greatest timing for fiscal restraint as the economy is fragile and recession risks are high.” But, he said, “it is manageable.”
 
Other economists say the economy could actually use a mild dose of fiscal austerity right now. That is because the biggest economic problem is persistent inflation, which is being driven in part by strong consumer spending. Removing some federal spending from the economy could aid the Federal Reserve, which has been trying to get price growth under control by raising interest rates.
 
 “From a macroeconomic perspective, this deal is a small help,” said Jason Furman, a Harvard economist who was a deputy director of Mr. Obama’s National Economic Council in 2011. “The economy still needs cooling off, and this takes pressure off interest rates in accomplishing that cooling off.” “I think the Fed will welcome the help,” he said.
 
Economists generally consider increased government spending — if it is not offset by increased tax revenues — to be a short-term boost for the economy. That’s because the government is borrowing money to pay salaries, buy equipment, cover health care and provide other services that ultimately support consumer spending and economic growth. That can particularly help lift the economy at times when consumer demand is low, such as the immediate aftermath of a recession.
 
Biden and McCarthy confident of debt deal securing Congress approval
 
President Joe Biden and House Speaker Kevin McCarthy expressed confidence that their debt-ceiling deal will pass Congress, averting a historic US default while setting a course for federal spending until after the 2024 election.
“The agreement prevents the worst possible crisis,” Biden told reporters at the White House on Sunday after finishing his deal with McCarthy, calling it a bipartisan compromise.
 
“No one got everything they want,” he added. “But that’s the responsibility of governing. I strongly urge both chambers to pass that agreement.”
 
Biden and McCarthy sealed a tentative deal in a 90-minute phone call late Saturday, clearing the way for a push to shepherd the agreement through Congress — likely over the objections of both liberals and conservatives  — before the US government runs out of borrowing capacity in about a week.

First Published: May 29 2023 | 11:05 PM IST

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