Budget cuts raise doubt on course of recovery
WASHINGTON — The budget deal struck last week amounts to a bet by the Obama administration that the loss of $38 billion in federal spending will not be the straw that breaks the back of a fragile economic recovery.
Economic conditions can determine the outcome of elections, and growth remains tepid and tentative just 18 months before voters decide if President Barack Obama gets a second term.
The proposed federal spending cuts, which were decided late Friday, do not amount to much by themselves — about 0.25 percent of annual domestic activity. But they join a growing list of minor problems impeding growth, economists said, including higher fuel prices and bad weather, Europe’s creeping malaise, and the effects of the earthquake and tsunami in Japan.
The impact of those problems, combined with growing cuts in spending by federal, state, and local governments, has led some experts who had forecast that the economy would expand by more than 4 percent in 2011 to retreat toward a 3 percent growth rate. And it raises the question of how many more small cuts the president can afford.
Diane Swonk, chief economist at Mesirow Financial, a Chicago investment firm, said she had cut her forecast for 2011 to 3.3 percent, from 4.2 percent. And if growth falls below 3 percent, she said, “You’re just running on a treadmill. You’re not getting anywhere.”
There are reasons for optimism. The Federal Reserve and private forecasters say that the economy’s vital signs are getting steadily stronger. Factories are expanding production and people are buying more cars, leading forecasters like the firm Macroeconomic Advisors of St. Louis to predict that growth will accelerate after the first quarter.
Moreover, supporters of the cuts say that reduced government spending will stimulate economic growth, not dampen it — and that the president could be among the political beneficiaries.
As the government spends less it borrows less, and companies can borrow more. As the government collects less money in taxes, companies may increase spending and investment.
“This cut combined with other cuts in entitlement reform will give the economy and businesses and investors some positive news on the fiscal front in Washington,” said Chris Edwards, director of tax policy studies at the Cato Institute, a libertarian think tank that favors even larger reductions in the federal spending.
There is also the potential that the budget deal will serve as a precedent for a broader deal on long-term spending. Economists say that such a deal would have immediate economic benefits, soothing the nerves of foreign investors who may be fretting about the government’s ability to confront its problems.
“I think the cuts are perfectly digestible in the context of the current expansion,” said Mark Zandi, chief economist of Moody’s Analytics. “And if out of this process it appears that we’ve made a good step toward fiscal discipline … then it could be a plus.”