New York Times
POSTED: 1:30 a.m. HST, Feb 27, 2013
WASHINGTON » The federal government, the nation's largest consumer and investor, is cutting back at a pace only exceeded in the last half-century by the military demobilizations after the Vietnam War and the Cold War.
And the turn toward austerity is set to accelerate Friday if the mandatory federal spending cuts known as sequestration start to take effect as scheduled. Those cuts would join an earlier round of deficit reduction measures passed in 2011 and the wind-down of wars in Iraq and Afghanistan that already have reduced the federal government's contribution to the nation's gross domestic product by almost 7 percent in the last two years.
The cuts may be felt more deeply because state and local governments — which expanded rapidly during earlier rounds of federal reductions in the 1970s and the 1990s, offsetting much of the effect — have also been cutting back.
Federal, state and local governments now employ 500,000 fewer workers than they did on the eve of the recession in 2007, the longest and deepest decline in total government employment since the aftermath of World War II.
Total government spending continues to increase, but those broader figures include benefit programs like Social Security. Government purchases and investments expand the nation's economy, just as private-sector transactions do, while benefit programs move money from one group of people to another without directly expanding economic activity.
The Federal Reserve and other economic forecasters say that the latest round of government austerity is not likely to return the economy to recession, thanks to stronger private-sector growth. But the spending cutbacks and actions to raise taxes could reduce growth by roughly 1.5 percentage points this year, according to the Congressional Budget Office, leaving the sluggish economy operating well below capacity.
In testimony to lawmakers on Tuesday, the Fed chairman, Ben S. Bernanke, urged Congress and the Obama administration to replace the scheduled budget cuts with a plan to reduce federal deficits more gradually.
"Although monetary policy is working to promote a more robust recovery, it cannot carry the entire burden of ensuring a speedier return to economic health," Bernanke said. He warned that the combination of previous spending cuts and the looming mandatory reductions "could create a significant headwind for the economic recovery."
The shrinking government is a normal response to an extraordinary situation. Government spending generally rises during recessions and falls as the economy recovers. Spending always declines at the end of one war, let alone two. And three years after a recession, the U.S. economy typically is restored to full health.
But this time is different. Growth has remained sluggish and millions remain unemployed even as the federal government, out of patience and stalemated by a deep partisan divide, has largely turned its attention to deficit reduction.
Bernanke, like many critics of sequestration, said the government could not ignore the need to reduce its annual deficits and curtail the growth of its debt. But he said short-term cuts would worsen those problems by slowing the economy. Moreover, sequestration mostly spares Medicare and Medicaid, the health care programs that are the primary reason federal spending is projected to increase.
Congress and the administration, he said, should "introduce these cuts more gradually and compensate with larger and more sustained cuts in the future."
Others, however, say that it makes no sense to postpone inevitable cuts. They note that government cutbacks may cause short-term pain, but also tend to provide long-term benefits by making resources available to the private sector.
"People focus on the upfront cost and they don't think through the whole timeline," said Tyler Cowen, an economist at George Mason University and an occasional contributor to the Sunday Business section of The .. "You have to cut spending within the next 10 years anyway. It may be time to take some lumps."
The current round of austerity does not yet approach the depth or the duration of the earlier round of cutbacks. Between 1969 and 1974, as spending on the Vietnam War declined, the government reduced consumption and investment by 24 percent after adjusting for inflation. Between 1991 and 1999, the government reduced consumption and investment by an inflation-adjusted 14 percent.
Over the last two years, federal consumption and investment declined by 6.9 percent. Including state and local consumption, a larger category that has declined more slowly, the inflation-adjusted reduction since 2011 was 4.9 percent.
But Alec Phillips, an economist at Goldman Sachs, estimated that federal consumption could fall by another 11 percent over the next two years. Moreover, Phillips noted that those earlier rounds of cuts in the 1970s and the 1990s came primarily from the military budget. The sequester is designed to be indiscriminate, cutting everything from air traffic control to nursery schools.
That could increase the resulting pain, because economic research suggests that military cuts are less painful than other kinds of spending reductions. "It is cutting some of the best spending that government does," Cowen said of the cuts that would fall on the domestic side of the ledger.
He said Congress should focus instead on cuts to military spending, farm subsidies and health care programs like Medicare that he regarded as ripe for reductions.
He said that military contractors and personnel might be able to find new jobs with relative ease, because unemployment rates are fairly low for well-educated workers; it is those with less education who are struggling most.
An important reason for the depth of the current cutbacks is that the federal government mounted an unusually large response to the recession, even adjusting for its severity, according to research by the Federal Reserve Bank of San Francisco.
Federal spending expanded to equal almost 25 percent of annual economic output in 2009, well above the 23 percent share that would have been expected based on past recessions, the San Francisco Fed found.
But that pattern has now flipped. While federal spending remained above the historical trend until earlier this year, scheduled cuts over the next two years would push government spending well below the trend.
"History shows that discretionary fiscal policy often helps to support a recovery," Janet Yellen, vice chairwoman of the Federal Reserve, said in a recent speech. "Discretionary fiscal policy this time has actually acted to restrain the recovery."
She added: "I expect that discretionary fiscal policy will continue to be a headwind for the recovery for some time, instead of the tail wind it has been in the past."