Why cuts in the debt limit are unlikely to shake the economy
The last time the United States came perilously close to defaulting on its debt, a Democratic president and a Republican speaker of the House struck a deal to raise the nation’s borrowing limit and limit some federal spending growth in the coming years. The deal averted a default, but it hindered what was already a slow recovery from the Great Recession.
The debt deal that President Biden and Speaker Kevin McCarthy have agreed to in principle is less restrictive than the one that President Barack Obama and Speaker John Boehner cut in 2011, centered on just two years of spending cuts and caps. The economy that will absorb these cuts is in much better shape. As a result, economists say the deal is unlikely to inflict the kind of lasting damage to the recovery that was caused by the 201[ads1]1 deal on the debt ceiling — and paradoxically, the newfound spending restraint may even help it.
“For months I had worried about major economic consequences from the negotiations, but the macro impact appears to be negligible at best,” said Ben Harris, a former undersecretary of state for economic policy who left the post earlier this year.
“The main impact is the stability that comes with having an agreement,” Mr. Harris said. “The markets can function knowing that we don’t have a catastrophic debt ceiling crisis coming.”
Mr. Biden expressed confidence earlier this month that any deal would not trigger an economic downturn. That was partly 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.
At a news conference at the Group of 7 summit in Japan this month on whether spending cuts in a budget deal would lead to a recession, Biden replied: “I know they won’t. I know they won’t. In fact, the fact that we were able to cut government spending by $1.7 trillion did not cause a recession. That led to growth.”
The draft agreement must still pass the House and Senate, where it faces opposition from the most liberal and conservative members of Congress. It goes well beyond the spending limits, including new work requirements for food stamps and other government assistance and an effort to speed up permitting for some energy projects.
But the centerpiece is spending limits. Negotiators agreed on small cuts in discretionary spending — outside of defense and veterans’ care — from this year to next, after factoring in some accounting adjustments. Military and veterans spending will increase this year to the amount requested in Mr. Biden’s budget for fiscal year 2024. All of these programs will grow by 1 percent in fiscal year 2025 — which is less than they were projected for.
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 projections, and by another $81 billion in 2025.
The first back-of-the-envelope analysis of the deal’s economic impact came from Mark Zandi, a Moody’s Analytics economist. He had previously estimated that a prolonged default could kill seven million jobs in the US economy — and that a deep round of proposed Republican spending cuts would kill 2.6 million jobs.
His analysis of the new 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 estimated, and the unemployment rate would be about 0.1 percent higher.
MR. They sound wrote on Twitter Friday that it was “Not the best timing for fiscal restraint as the economy is fragile and recession risks are high.” But, he said, “it’s manageable.”
Other economists say the economy could actually use a mild dose of fiscal tightening right now. That’s because the biggest economic problem is persistent inflation, driven in part by strong consumer spending. Removing some federal spending from the economy could help the Federal Reserve, which has been trying to get inflation under control by raising interest rates.
“From a macroeconomic perspective, this deal is a little help,” said Jason Furman, a Harvard economist who was deputy director of Mr. Obama’s National Economic Council in 2011. “The economy still needs to cool, and this takes pressure off interest rates to achieve that cooling.”
“I think the Fed will welcome the help,” he said.
Economists generally consider increased government spending – if not offset by increased tax revenues – as a short-term boost to the economy. That’s because the government borrows money to pay wages, buy equipment, cover healthcare and provide other services that ultimately support consumer spending and economic growth. It can especially help lift the economy at times when consumer demand is low, such as the immediate aftermath of a recession.
That was the case in 2011, when Republicans took control of the House and forced a showdown with Mr. Obama on raising the borrowing limit. The nation was slowly climbing out of the hole created by the financial crisis of 2008. Unemployment was 9 percent. The Federal Reserve had cut interest rates to near zero to try to spur growth, but many liberal economists called on the federal government to spend more to help bolster demand and accelerate job growth.
The budget deal between Republicans and Mr. Obama — hammered out by Mr. Biden, who was then vice president — did the opposite. It reduced federal discretionary spending by 4 percent in the first year after the deal compared to the benchmark estimate. In the second year, it reduced spending by 5.5 percent compared to forecasts.
Many economists have since blamed those cuts, along with too little stimulus spending at the start of the recession, for prolonging the pain.
The agreement announced on Saturday contains smaller cuts. But the even bigger difference today is economic conditions. Unemployment is at 3.4 percent. Prices are growing at more than 4 percent a year, well above the Fed’s target rate of 2 percent. Fed officials are trying to cool economic activity by making it more expensive to borrow money.
Michael Feroli, a JPMorgan Chase analyst, wrote this week that the right way to assess the new deal was in terms of “how much less work the Fed needs to do to curb aggregate demand because fiscal policy tighteners are now doing that job.” Mr. Feroli estimated that the deal could work the equivalent of a quarter-point rate hike in helping to contain inflation.
Although the deal will only modestly affect the nation’s future deficit levels, Republicans have argued that it will help the economy by reducing the accumulation of debt. “We’re trying to bend the cost curve of government for the American people,” Representative Patrick T. McHenry of North Carolina, one of the Republican negotiators, said this week.
Still, the spending cuts from the deal will affect non-defense discretionary programs, like Head Start preschool, and the people they serve. New work requirements could choke off food and other aid to vulnerable Americans.
Many progressive Democrats warned this week that these effects will amount to their own form of economic damage.
“After inflation eats its share, flat funding will result in fewer households accessing rental assistance, fewer children in Head Start and fewer services for seniors,” said Lindsay Owens, executive director of the liberal Groundwork Collaborative in Washington.
Catie Edmondson contributed reporting.
