Economists Debate Sequestration's Total Effect

Correction March 1, 2013

The reference to direct cuts in government spending in calendar year 2013 caused by the sequester should be $64 billion, not $66 billion.

The Congressional Budget Office estimates the automatic budget cuts that go into effect Friday will shave 0.6 percent from the economy's annual growth rate. That might not be a big worry if the economy were growing at 3 or 4 percent. But growth is a paltry 2 percent, so the impact may be noticeable.

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STEVE INSKEEP, HOST:

It's MORNING EDITION from NPR News. I'm Steve Inskeep.

RENEE MONTAGNE, HOST:

And I'm Renee Montagne. Here we are - Friday, March 1. The law that established the automatic, across-the-board spending cuts also says they go into effect today. Exactly when, and even if, is still a question. The White House has until 11:59 p.m. Eastern Time to put the actual sequestration process into effect. And the president has called congressional leaders to the White House in hopes of keeping that from happening.

INSKEEP: The budget cuts that agencies could be forced to make would remove tens of billions of dollars from the economy, and create headwinds to growth. As NPR's John Ydstie reports, there's disagreement about just how much growth could suffer.

JOHN YDSTIE, BYLINE: You've no doubt heard from President Obama that the economy will take a serious hit from the automatic spending cuts. You've also heard from House Speaker John Boehner that the president is crying wolf because the cuts aren't that large.

That argument played out yesterday when two economists, one aligned with each of the parties, faced off at the Joint Economic Committee on Capitol Hill. Here's Michael Boskin, a professor at Stanford who's been an adviser to Republican presidents for decades.

MICHAEL BOSKIN: It would take quite a stretch to make this into a major macro-economic event this year.

MONTAGNE: And here's Austan Goolsbee, formerly President Obama's top economist, now at the University of Chicago's Booth School of Business.

AUSTAN GOOLSBEE: In my view, this will cut the growth rate and will cut it by enough so actually, there's a decent chance the unemployment rate starts to go back up again, instead of starting to come back down.

YDSTIE: The difference of opinion between Goolsbee and Boskin has a lot to do with something called a multiplier.

GOOLSBEE: Professor Boskin and I disagree a little bit on what the multiplier would be.

YDSTIE: The multiplier is simply a calculation of how many ripple effects the cuts in government spending will have. Greg Daco, a senior economist at IHS Global, says it's a pretty simple concept. Take the situation of a government contractor, whose contract takes a whack from the government cutbacks. So he cuts back on dining at his favorite restaurant.

GREG DACO: And that is an indirect impact of the sequester on the economy.

YDSTIE: The nonpartisan Congressional Budget Office uses a multiplier of 1.5. For every dollar of cuts to government programs, they figure there'll be an added 50 cents in negative ripple effects from things like those missed restaurant meals. So let's do a quick calculation. The CBO says between today and December 30 of this year, direct government spending will fall $66 billion because of the sequestration. [POST-BROADCAST CORRECTION: The CBO says government spending will fall $64 billion.]

So to figure out the full effect of that, CBO analysts multiply 1.5 times $66 billion. That equals a $96 billion hit to the economy from the sequester in 2013. Federal Reserve chairman Ben Bernanke described to Congress what that means for growth and jobs, earlier this week.

(SOUNDBITE OF CONGRESS)

BEN BERNANKE: It would cost about sixth-tenths of a percent of growth in this year, and the equivalent of about 750,000 jobs.

YDSTIE: And, Bernanke pointed out, the recent deficit reduction deals between the president and Congress, involving $2.5 trillion dollars in tax hikes and budget cuts, are already putting a drag on the economy equal to about 1 and a half percent of growth. That's left the economy growing at just 2 percent a year. So will shaving off another half a percent, or so, off create a big risk of recession? Greg Daco doesn't think so.

DACO: I would say it's highly unlikely that the sequester will push us back into a recession.

YDSTIE: Professors Goolsbee and Boskin agree - and that's the mainstream view. But there are some economists worried that the multiplier will be much greater because, they say, the sequester will be chaotic. For instance, furloughed USDA meat inspectors could cause shutdowns of meat-processing plants, temporarily forcing their workers into layoffs.

And furloughed air traffic controllers could seriously disrupt air travel and business. These, and potential micro events like them, are not captured in the multipliers used by the CBO or most forecasters. If those kinds of events cause enough chaos, the economy could face headwinds even stronger than expected.

John Ydstie, NPR News, Washington.

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