Self-Flagellation, Revisited

Following up on a previous item, Macroeconomic Advisers have updated their analysis in response to the most recent debt ceiling deal.  The results:  no good news, and some serious uncertainty in the probable effects on growth (though not the sort of “uncertainty” the conventional wisdom is persistently telling us we should care about).

In 2012, they estimate that the fiscal drag resulting from budget cuts is likely to hover around 0.1 percentage points.  If that strikes you as a minor blip, note that they have not included multiplier effects in their estimates.  The Economic Policy Institute, using standard multipliers, estimate that the ultimate damage in 2012 would amount to a reduction of 0.3 percentage points in GDP, or, if that still doesn’t get your attention, around 323,000 fewer jobs.

When adding in the effects of the expiration of the unemployment insurance extensions (528,000 fewer jobs) and the payroll tax cuts (972,000 jobs), EPI suggest that we should expect the economy to shed somewhere on the order of 1.8 million jobs as a result of these policy choices.

While the administration, via Tim Geithner op-ed, signaled today that it would like to extend both the unemployment insurance and payroll tax cut measures, as well as to initiate new infrastructure investments, it takes a certain amount of imagination to see how any of these measures—even the extension of tax cuts—could get through Congress in the current climate.

If that still doesn’t faze you, consider that in 2013, as a result of the debt ceiling deal, things really start to get dicey.

The reason has to do with the design of the debt ceiling agreement.  If the “super committee” created by the deal is unable to come to agreement on $1.5 trillion in additional deficit reduction (and it is an open question whether that resulting agreement would be front- or back-loaded), then automatic cuts of $1.2 trillion will be triggered.  In this scenario, however, the triggered cuts are largely front-loaded.  This would mean a loss of 0.8 points to 2013’s GDP (again, before multipliers)—a “major fiscal shock,” as Macroadvisers put it.

At this point, we are running out of ways to express how damaging austerity of this magnitude will be—and how futile.  For the futility of it all, see Levy Institute Senior Scholar James Galbraith’s Policy Note on the question of the “sustainability” of rising debt levels, as well as Senior Scholar Randall Wray’s responses to the hysteria over rising debt-to-GDP ratios.