It’s fiscal fight season in Washington all over again. The second tranche of the sequester, which mandates another $17 billion-worth of automatic cuts, will kick in at the beginning of the new fiscal year on October 1, unless Congress decides otherwise. And somewhere between mid-October and mid-November the Treasury will run out of stop-gap measures to keep paying the government’s bills and the debt ceiling will have to be raised. On Tuesday, the Obama Administration tried to spin some old ideas on corporate tax cuts and infrastructure spending as a new “grand bargain” aimed at stemming another confrontation on fiscal policy. The Republicans took all of two seconds to reject it wholesale. The media are gearing up for what promises to be another bloody match.
The crucial question for Canada and other countries hoping to grab onto Uncle Sam’s coattails is: Could this put a sizable dent in the U.S. recovery?
Here are a few considerations:
The impact of a fiscal standoff on consumer confidence and investor sentiment might be limited this time. About a month ago, I advanced the hypothesis that Americans had seen too many of these kerfuffles in recent years to take the latest one seriously. Consumers, trusting that the world would not come to an end, will continue to buy washing machines, trucks and—crucially—houses. Investors, who have already priced in the risk of a politically paralyzed Washington, are supposedly less prone to panic.
On the other hand, the direct effects of a new round of spending cuts and freezes would still be meaningful. The impact of a second round of automatic spending cuts would be serious. A recent estimate by the Congressional Budget Office found that repealing the sequester would boost GDP by 0.7% and employment by 900,000 jobs by September 2014. In a recent research note, CIBC’s Emanuella Enenajor seemed to indicate that avoiding a repeat of the sequester is more important even than continued momentum in the housing market. Construction, she calculated, will contribute 0.4% to GDP growth in 2014, a sequester 2.0 could shave off 0.8%.
Another fiscal impasse could send public and financial confidence plummeting if it comes on top of concerns about rising interest rates. Americans might have grown accustomed to fiscal-cliff type crises, but they’ve never seen how an $85 billion-a-month bond-buying program winds down. To stage another fiscal drama just as the Federal Reserve starts to roll back its quantitative easing policy (which will put upward pressure on interest rates, including those on residential mortgages) would like banging pots and pans in the midst of an already distressed cattle. There’s a chance nothing will happen, but it just doesn’t seem like a good idea.
In sum, more fiscal tightening would likely have serious if not catastrophic consequences. The U.S. economy has been sputtering along despite the sequester. Even the debt-ceiling fight cum credit downgrade of 2011 wasn’t enough to knock it off the path of (painfully) slow progress its been on since the recession officially ended in 2009. On the other hand, more spending cuts could certainly stifle the economic rebound everyone expects to see in the second half of the year after the flimsy performance of this just-ended second quarter.
Erica Alini is a California-based reporter and a regular contributor to CanadianBusiness.com, where she covers the U.S. economy.