In mid-February a young man named Alec Phillips, an analyst at Goldman Sachs who tracks “political risks” for the investment bank, wrote a confidential report on the economic impact of a proposal to significantly reduce federal discretionary spending in the current year. The report was sent to a select list of the clients of the world’s largest and most successful investment bank including large corporations, financial institutions, and high-net-worth individuals.
Phillips warned that the size and timing of the legislation might result in lower growth rates in the coming year than Goldman economists had projected two months earlier. “Under the House passed spending the drag on GDP growth from federal fiscal policy would increase by 1.5 percentage points to 2 percentage points in Quarter 2 and Quarter 3 compared with current law.” Instead of an economy that would grow by 3.4 percent over the course of the year as the firm’s economic unit had projected in December, the Phillips warning would appear to lower growth for the year to somewhere nearer 2.5 percent.
Phillips was not alone in his concern that the economic recovery was too weak to risk large and immediate budget cuts. The Bowles-Simpson deficit commission, widely noted for the severity of their proposed budget policies had made the identical warning and had proposed no spending reductions in the current fiscal year.
More than a week after the Goldman report was leaked to the press, Mark Zandi of Moody’s Corporation released an analysis of how he believed the $61 billion package of budget cuts moving through the House of Representatives would impact economic growth and employment. Zandi helps Moody’s advise its clients—large banks, insurance companies, pension funds, and other investors in corporate bonds—and determine the level of risk they face in purchasing such bonds.
Zandi, who began the year more pessimistic than the economists at Goldman, said that he would need to pare back his projections further if the package passed in its present form. His late-February analysis argued that the package would result in a 0.5 percent slowdown in forecasted growth in 2011 and a 0.2 percent decline in 2012. While the biggest impact on economic growth would be in the current calendar year, the biggest impact on employment according to Zandi would be in 2012. He predicted a loss of 200,000 jobs by December 2011 and a 700,000 job loss in 2012.
While the Moody and Goldman forecasts for overall growth differ, their disagreement in assessing the impact of the Republican spending package are not as significant as they might seem. The Goldman analysis was done shortly after the contents of the package were revealed and before the full details were available. Phillips assumed that the reduced flow of funds out of the Treasury caused by the spending proposal would take place quickly and largely occur during the five or six months following the adoption of the resolution. He therefore believed that there would be a much deeper and more immediate impact but also one that lasted a shorter time.
Zandi on the other hand used traditional Congressional Budget Office projections of how quickly the cuts would stop the flow of dollars through the economy. The CBO projections based on historical averages indicate the proposed cuts will result in a reduction in the flow of funds from the Treasury that will be substantially slower than the rate assumed by Phillips but will impact the economy for a much longer period of time.
In truth, the impact of the legislation on overall government outlays or “spend out” rates is still uncertain as agency budget offices continue struggling with strategies on how to absorb deep cuts in annual funding levels that must be implemented in a period of less than six months. The key point here, however, is that the major difference between the 1.5 to 2.0 percent forecast by Goldman and the .05 and 0.2 percent forecast by Moody’s is one of timing rather than overall impact. Absent the question of when drag on economic growth will occur, the two projections are relatively similar.
I don’t build economic models or make economic forecasts but I do know that when money is spent, jobs are created. This is particularly true in a down economy. Federal Reserve statistics indicate that in February, the U.S. economy was operating at only 76 percent of its industrial capacity—meaning the nation has a serious shortfall in the demand needed to absorb the goods and services the nation was capable of producing.
A study in May of 2009 by the Council of Economic Advisors estimated that, on average, each $92,000 the federal government spends creates one full year’s worth of work—whether it is 12 months of work for a single employee or 12 months worth of work divided amongst multiple workers. Using that figure, I estimated for The Washington Post that the $61 billion in cuts contained in the continuing resolution under consideration in the House of Representatives would erase about 650,000 jobs (or years of work) directly and eliminate another 325,000 as the cuts rippled through the economy for a total loss of a little less than 1 million jobs.
If we look at the Zandi estimates in terms of the number of years of employment lost over time rather how much national employment levels will be reduced in December 2011 and December 2012 we get a number higher than the projection for either time period. Assuming that job losses begin when the legislation is adopted in mid-April and builds as Zandi projects to 200,000 by this December and 700,000 the following December declining back to zero over the course of the following year you get a number somewhat greater than 1 million years of employment lost. Zandi’s projections comport closely with the job loss number that the CEA analysis would suggest.
But much of the public concern over these warnings seemed to dissipate when Federal Reserve Chairman Ben Bernanke said at a congressional hearing on March 2 that the impact on GDP would be a -0.2 percent this year and a -0.1 percent next year. He said that the package would cost “a couple of hundred thousand jobs.”
The first thing that should be noted is that all of these estimates—including Bernanke’s and a number of others that I have not cited—are in agreement that the package will cost jobs and slow economic growth. But it is curious that the predictions of the nation’s most prominent private economic forecasters would be at such great variance with those of the economists advising the chairman of the Federal Reserve. One could infer—as House Speaker John Boehner has—that the forecasters at Goldman and Moody’s are left-leaning academics with partisan axes to grind.
That explanation may get applause at gatherings of the House Republican Conference but they hardly wash with anyone even modestly more thoughtful. Phillips and Zandi are in a tough, demanding, and highly profitable business. Their reputation for impartiality, detail, and accuracy are the credentials that keep their high-priced clients coming back. I know nothing of Phillips’s political leanings but Zandi was actually an economic advisor to the McCain presidential campaign. Neither strikes me as willing to cut corners in their forecasting business to engage in partisan activities on behalf of either party.
So maybe there is an issue with the Fed chairman’s prognostication. I tried unsuccessfully to reach someone at the Fed to get an explanation of how the estimate was put together. How much, for instance, did they assume the amount cut from the current year budget would actually reduce dollars flowing from the Treasury over each of the next six quarters? My call was not returned but I did reach a congressional staffer who had been in contact with the Fed over the same issue. The staffer was told that there was no formal analysis prepared. The chairman responded based on “very back of the envelope calculations.” The Fed would not release or discuss any of the assumptions made in those calculations or further interpret any comments the chairman had made.
This would not be the first time in the past decade that a Fed chairman has injected himself into the wrong side of congressional debate—helping tip the balance in favor of wrong-headed policy. It took Alan Greenspan nine years to reverse his unfortunate endorsement of the Bush tax cuts that have contributed so much to the current economic crisis. In calling for the complete repeal of the 2001 and 2003 tax cuts—which might well have been subjected to greater scrutiny without his support—he told The New York Times, “Our choices right now are not between good and better; they’re between bad and worse. The problem we now face is the most extraordinary financial crisis that I have ever seen or read about.”
We are at another critical juncture and I suspect that Chairman Bernanke has played a more important role in this discussion than he intended or perhaps even realizes. Such pronouncements by one of the most powerful and respected voices in the world should not be based on back of the envelope calculations, and the calculations that are made to back them up ought to be subject to public scrutiny.
If the job impact of the $38.5 billion compromise package is extrapolated from the chairman’s estimate of the impact from the original package (“a couple hundred thousand jobs”)—a the compromise package 63 percent the size of original package should result in job losses that are 63 percent as large as the chairman forecasted. That would leave us with a job loss of about 200,000 at a time we can ill afford to give up so many jobs. But if the calculations of the pre-eminent private forecasters are correct, the losses will be more than three times that size and could lead us into a double-dip recession with a catastrophic impact on not just human life but also the all-important budget deficit.
Scott Lilly is a Senior Fellow at American Progress.