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Sharp Spending Cuts Associated with a Downgraded Economy

Economist Forecasters Know the Score

SOURCE: AP/Jacquelyn Martin

The Republican-led House of Representatives has chosen to cut spending, even with a staggering 14 million people out of work, leading to increasingly gloomy economic forecasts.

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The 2012 national election is more than a year away, yet some key constituencies are already voting on the economic policy platforms pursued by progressives and conservatives—namely private-sector economic forecasters.

Throughout 2011, the Republican leadership in the House of Representatives pursued only one goal, spending cuts, even at the risk of throwing the country into default. One way to measure the success or failure of this economic policy agenda is to understand how it will affect economic growth, or how it will affect investors’ perceptions of where the economy is headed.

As the Republican leadership pushed their cuts, cuts, and more cuts agenda forward, professional economic forecasters grew increasingly gloomy on where the U.S. economy was headed. Each month, The Wall Street Journal surveys professional economic forecasters, most of whom work for banks or investment firms, on their projections for U.S. economic growth. The accompanying chart shows how forecasts for growth of U.S. gross domestic product, or GDP—the total value of all goods and services produced in the United States, less imports—for the fourth quarter of 2011 evolved over time.

change in forecast

Let’s follow that timeline of predictions in the chart. Following a range of policy efforts in 2009 and 2010 to boost employment and economic growth, economic forecasters began predicting that GDP would grow at a pace solidly above 3.0 percent annually by late 2011. This is the historical average rate for the U.S. economy. By early spring 2011, forecasters were predicting growth at year end would be more than 3.5 percent

While the first three months of the year saw relatively robust forecasts for future economic growth, economic forecasters quickly began to downgrade their predictions for the U.S. economy as the year wore on. In April 2011, Washington policymakers began a full-scale debate about shutting down the federal government. By late summer of 2011, in their push for steep, immediate cuts, Republicans threatened to force the U.S. government into an unheard of default rather than to follow routine practice of raising the debt ceiling as had happened seven times under President George W. Bush.

Downgrades in forecasters estimate of future GDP growth quickly followed—with good reason. Not raising the debt ceiling would have slashed government spending by more than in half, a sharper economic contraction than any time during the Great Recession.

In the end, Republican lawmakers largely got their way. To avoid the threat of default, Congress and President Obama agreed to sharp near-term reductions in public services and investments. As a result, economic forecasters dramatically cut their projections for future U.S. economic growth.

In total, since the political ascendency of the fiscal contraction agenda, professional forecasters in The Wall Street Journal have downgraded U.S. economic growth prospects by 1.2 percentage points, or by more than one-third.

Economists across the spectrum, including financial analysts whose main concern is an accurate prediction so their clients know where to invest for the highest profits, have come to the conclusion that the U.S. economy right now needs more support from government policy, not less. With unemployment and job growth stalled and families and businesses continuing to suffer from an overhang of debt from the housing bubble, cutbacks in government spending will only exacerbate the lack of demand for goods and services that is dragging down the economy.

Employers are not hiring because they are not seeing enough customers coming through their doors. The National Federation of Independent Businesses, an organization representing small business owners, reported in June, that “weak sales” are small business owners’ biggest problem:

“It is simple: when sales pick up, owners will have a reason to hire more workers to take care of customers, to produce more output and will have a reason to invest in new equipment and expansion. The proximate cause of the collapse of spending in 2008 was reduced consumer spending.”

A lack of demand is what is preventing firms from hiring, as was said this July by Martin Feldstein, professor of economics at Harvard University and former chairman of the Council of Economic Advisers under President Ronald Reagan, “The high unemployment reflects the lack of demand rather than any fundamental problems with the U.S. labor market.”

The Republican-led House of Representatives has chosen, however, to cut spending, even with a staggering 14 million people out of work. Last month, for example, they insisted on holding up reauthorization of the Federal Aviation Administration, a move that led to the immediate furlough of 4,000 government workers and another 70,000 construction employees and halted much-needed investments in our air transport system.

“Cut, cap, and balance” is not an economic growth strategy, it’s a job-killing agenda. If it were, economic forecasters would have responded with rosier, not grimmer, forecasts over the spring and summer of 2012.

Heather Boushey and Adam Hersh are economists at the Center for American Progress.

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