The economy has survived austerity thus far this year thanks to housing, but the sequester’ could change that.
Sequester is a procedure in United States law that limits the size of the federal budget. It involves setting a hard cap on the amount of government spending within broadly-defined categories; if Congress enacts annual appropriations legislation that exceeds these caps, an across-the-board spending cut is automatically imposed on these categories, affecting all departments and programs by an equal percentage. This part of the fiscal cliff became effective on January 1, 2013, but the American Taxpayer Relief Act of 2012 delayed it until March 1.
When Barack Obama and the Republicans in Congress agreed on January 1st to let a payroll tax cut expire and tax rates rise on the rich, they rolled the dice with the economy. They, in effect, bet that America’s recovery was solid enough to withstand higher taxes and spending cuts, including a ‘sequester’ that took effect on March 1st. At 1.9% of gross domestic product, that is a contraction second only to that of Greece among rich countries this year.
At America’s biggest retailer, it looked at first like the gamble had not paid off. ‘Where are all the customers? And where’s their money?, one executive at Walmart said in an e-mail dated February 1st. February sales to date ‘are a total disaster’ another wrote on February 12th.
But the company painted a less dire picture on February 21st, when it reported its earnings. While sales had indeed flattened out, the culprit was not, it appeared, the tax increases, but delayed tax refunds (also a result of the January 1st legislation). Customers last year cashed $4 billion worth of income tax refunds at Walmart’s shops, but so far this year had cashed only about $1.7 billion. Presumably when the refunds come through in March, so will the usual spending they bring.
For now, the economy seems to have shrugged off austerity. GDP, which stalled at the end of 2012 because of one-off factors including Hurricane Sandy, now seems to be growing at about a 2% annual rate, Ben Bernanke, the Federal Reserve chairman, said on February 26th; that is the same, uninspiring pace it averaged throughout 2012. In effect, the economy is caught between headwinds and tailwinds that have roughly cancelled each other out. The headwinds, besides the government’s austerity, include a rise in petrol prices that could trim 0.2% off this year’s GDP by depressing consumption.
Rising home prices should also loosen the supply of mortgage credit by making default, foreclosure and litigation less likely. John Williams, president of the San Francisco Fed, recently spoke of a virtuous circle, ‘with sales volumes growing, home prices increasing, and foreclosures coming down’.
Yet it is far too soon to declare the experiment with austerity a success. The sequester still looms, and its effects are unpredictable. Mr Obama and Republicans agreed to sequester in 2011 purely as a spur to negotiate a more rational plan for reducing the deficit.
The sequester was originally designed to slice $1.2 trillion from spending over a decade. The initial installment is a cut of $85 billion for the seven months until the end of September, though that will reduce actual spending by only $42 billion since some money approved in one fiscal year is spent in the next. Most entitlements, such as pensions and health-care, are excluded, which makes the reduction in the rest more severe: 13% in defence spending for the next seven months and a 9% cut to other domestic discretionary programmes.
After long insisting that the sequester was too horrible even to contemplate, the Obama administration has finally begun to give details of its implementation. The cuts will come primarily through reduced grants, such as for Head Start, an anti-poverty programme for preschoolers, and staff furloughs (unpaid days off). Since the government must give at least 30 days notice of furloughs, and most agencies have not yet done so, the public may see no impact until April. With luck, the sequester may have been unpicked by then.
The National Cattlemen’s Beef Association claims the furloughing of meat, poultry and egg safety inspectors will affect 6,300 establishments and cause $10 billion in lost production. Likewise, the furlough of customs officers could result in huge delays at border crossings, crippling the supply chains that are crucial to the automobile industry, says one trade group.
Such predictions must be taken with a grain of salt since it is in each industry’s interest to sound the alarm. But the underlying point is correct. If you wanted to cut the deficit in the most damaging way, you’d choose the