Austerity Hurts: Budget Cuts Will Kill 700,000 Jobs

A Moody’s report finds that the budget proposal put forward by House Republicans could lead to 7000,000 fewer jobs by the end of 2012 and lead to “unnecessary risk” as the economy slowly recovers.

• Odds are uncomfortably high that the federal budget impasse will prompt a government shutdown.
  

• The Obama administration has shown significant spending restraint in its recent budget, but House Republicans want deeper cuts.
  

• While cuts and tax increases are necessary to address the nation’s long-term fiscal problems, cutting too deeply before the economy is in full expansion would add unnecessary risk.
  

• The House Republicans’ proposal would reduce 2011 real GDP growth by 0.5% and 2012 growth by 0.2 percentage points This would mean some 400,000 fewer jobs created by the end of 2011 and 700,000 fewer jobs by the end of 2012.
  

• A government shutdown lasting longer than a couple of weeks would do much more damage to the economy.
  

• Lawmakers are likely to split the difference between the administration and House Republican proposals. This isn’t ideal fiscal policy, but the economy will be able to manage through it.
  

• A compromise could send an encouraging signal about the more serious budget battles to come.

The political war is intensifying over the federal budget. Lawmakers are at loggerheads over how to cut government spending, raising prospects that government services will halt temporarily while the debate is resolved. Significant government spending restraint is vital, but given the economy’s halting recovery, it would be counterproductive for that restraint to begin until the U.S. is creating enough jobs to lower the unemployment rate. Shutting the government for long would put the recovery at risk, not only because of the disruption to public services but also because of the potential damage to consumer, business and investor confidence.

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While long-term government spending restraint is vital, and laying out a credible path toward that restraint very desirable, too much cutting too soon would be counterproductive. The economy is much improved and should continue to gain traction, but the coast is not clear; it won’t be until businesses begin hiring aggressively enough to meaningfully lower the still-high unemployment rate. The economy is adding between 100,000 and 150,000 per month—but it must add closer to 200,000 jobs per month before we can say the economy is truly expanding again. Imposing additional government spending cuts before this has happened, as House Republicans want, would be taking an unnecessary chance with the recovery.

This is particularly true given the added threat presented by rising oil prices. Unrest in the Middle East has pushed up the price of crude oil by about $10 per barrel; West Texas Intermediate is selling for almost $100 per barrel, and a gallon of regular unleaded gasoline has risen to about $3.25 nationwide. If sustained, these prices will shave about 0.2% from real GDP growth in 2011, a disappointing but manageable outcome. If oil prices approach $125 barrel, and gasoline reaches $4 per gallon, growth will slow sharply and unemployment will begin rising again. Should fuel prices return to their all-time high near $150 per barrel for oil and $4.50 per gallon for gasoline, the economy would sink back into recession. Such a price spike seems unlikely, but handicapping events in the Middle East with any precision is practically impossible.

Additional spending cuts would also be at cross-purposes with the government’s other economic policies. The Federal Reserve is holding short-term interest rates close to zero and purchasing hundreds of billions of dollars in long-term Treasury bonds, in an effort to hold down long-term interest rates. The Fed’s credit-easing efforts are scheduled to continue through June, and the central bank is likely keep interest rates near zero through 2011. Monetary authorities clearly remain nervous about the economy’s near-term prospects.

The tax cuts and benefit extensions lawmakers agreed to late in 2010 are also providing substantial temporary support to the economy. In addition to extending marginal personal tax rates for two years, the deal provided for a 2% payroll tax holiday in 2011, an extension of emergency unemployment insurance benefits through the end of the year, and—perhaps least appreciated in terms of its economic impact—the expensing of all business investment this year. The deal ensured that fiscal policy, which would have significantly weighed on the economy in 2011, will be largely neutral instead. Fiscal restraint was appropriately put off until 2012, when the expansion is likely to be in full swing.