The CBO's "Perfect Storm" Recession Looks Like EU Austerity

The Congressional Budget Office reports that the U.S. economy could nosedive in the first half of 2013 — unless Congress and the White House keep taxes low and do not cut federal spending too much. If the warning is right, Washington has run out of time, since the conventional wisdom is that the two political parties will do almost nothing before the election. The debate is like the one that has flared up in Europe as leaders fight over how to keep Europe out of deep recession and policies to preserve the eurozone, just as Greece tumbles and Spain and Portugal are on the brink.

The CBO’s new assessment of the effects of the budget and expected tax increases is this:

Under those fiscal conditions, which will occur under current law, growth in real (inflation-adjusted) GDP in calendar year 2013 will be just 0.5 percent, CBO expects — with the economy projected to contract at an annual rate of 1.3 percent in the first half of the year and expand at an annual rate of 2.3 percent in the second half. Given the pattern of past recessions as identified by the National Bureau of Economic Research, such a contraction in output in the first half of 2013 would probably be judged to be a recession.

This “scenario” could change, if only Congress and the Administration would revise their approaches and their plans to adjust the federal deficit to make it smaller:

CBO analyzed what would happen if lawmakers changed fiscal policy in late 2012 to remove or offset all of the policies that are scheduled to reduce the federal budget deficit by 5.1 percent of GDP between calendar years 2012 and 2013. In that case, CBO estimates, the growth of real GDP in calendar year 2013 would lie in a broad range around 4.4 percent, well above the 0.5 percent projected for 2013 under current law.

The swing of nearly 5% in GDP between the better case and the worse one may be too large to be credible. The debate in Europe between the International Monetary Fund and France on the one side and Germany on the other has brought similar claims of the difference between calamity and growth.

Tax increases may hamper economic activity, but the extent to which that is true is debatable. Some economists believe that most high taxes on businesses and individuals are regressive. The Bush tax cuts are assumed to have kept economic growth moderately strong because taxes rob consumers of their ability to consume. But other, negative factors, particularly the drop in home prices, have only held the consumer back so far. He has, in general, been relatively active, despite the housing crisis and unemployment. The latter has remained above 8% since 2008. Consumer confidence has improved by most measures over the past year. The consumer’s appetite for credit has moved higher recently.

While the effects of higher taxes and more stimulus cannot be known, the CBO has a theory:

[I]f policymakers wanted to minimize the short-run costs of narrowing the deficit very quickly while also minimizing the longer-run costs of allowing large deficits to persist, they could enact a combination of policies: changes in taxes and spending that would widen the deficit in 2013 relative to what would occur under current law but that would reduce deficits later in the decade relative to what would occur if current policies were extended for a prolonged period.

In other words, help the economy now and take the fruits of that later as rapid expansion improves the tax base, which lowers the deficit eventually.

The same debate about stimulus and government cost cuts is going on more urgently in Europe now. The EU summit is about to begin. Germany has warned Greece that if its steps back from austerity measures, its economy will be ruined and its future as a member of the eurozone club will be compromised. Germany also refuses to participate in a grand scheme to save the region economically that would involve, at least, a common bond to raise money for all countries, the weak and strong alike. Even less palatable for Germany, France and the IMF want aid to be given to Spain and Portugal as a means to take them out of recession and improve unemployment. Germany believes this will encourage these governments to waste money as they have in the past. These long-time bad habits make stimulus a risk. One the other hand, cost cuts are easy to measure and easy to enforce.

Enforcement is at the center of the debate because it can be measured. That is true whether the judge is Germany or Congress. Many leaders in America and Europe are willing to trade the tangible for a gamble, even if the gamble is the more likely route to a recovery.

Douglas A. McIntyre