After a few months of negotiations the debt super committee delivered its own turkey for the upcoming holiday season. The committee failed in its efforts to agree to reduce the deficit by at least $1.2tn. As a result, $1.2tn in automatic spending cuts kick in starting in 2013 through 2021. The near term consequence is that it reduces the probability that we will see a fiscal stimulus package in 2012. Without a stimulus there is a very good chance the US will fall into recession. Over the longer term, debt dynamics are little different than our baseline with the debt stabilizing by 2021.
Probably the most important impact of the committee’s failure is the near term influence it will have on the risks to the economic outlook. As we had flagged in earlier research, the absence of a deficit reduction proposal could decrease the likelihood that we will see any new stimulus programs in 2012. Democrats had been trying to tie in some stimulus as part of the deficit talks.
Any new stimulus would have to be paid for by future deficit reduction, and the most likely candidate is the money saved by the pullout of troops from Iraq. But key Republicans seem very reluctant to support any stimulus measures, even the extension of the payroll tax cuts which expire at the end of this year. It would have been easier to get any stimulus through Congress by way of a committee as part of a bipartisan plan. As well, it would have only required a simple majority to pass through the Senate. Now they will need a super majority of sixty votes.
There is also little time remaining this year to get a stimulus package passed. The House has adjourned for its week long Thanksgiving holiday break and is set to adjourn at around December 8 for the rest of the year. The House could extend the session to mid-December, but it still leaves little time to negotiate a deal, get it scored by the CBO, write the bill, debate the bill in Congress, and then put it to a vote. It is not impossible since the 2011 stimulus package fell into place quickly.
Our baseline scenario was for $180bn in stimulus for 2012 through the extensions of the payroll tax cuts and unemployment benefits. Without these measures the fiscal drag to growth would be 1pp to 1.5 pp. Given our forecast of 1.4% growth, the risk is that in the absence of an agreement on stimulus there is a high risk the US would fall into a recession in the first half of 2012.
The $1.2tn in automatic cuts are set to begin in 2013 with defense spending shouldering half of the burden. Defense is expected to see its budget shrink by $492bn over the next ten years. On the other hand, the overall spending cuts are similar to what we have estimated in our baseline with only some timing differences.
Deficits under the automatic cuts are expected to be the same as under our baseline scenario, at least through to 2018. After 2018 the deficit-to-GDP under the automatic cuts should begin to move higher relative to our baseline. This is due to CBO estimates on the automatic cuts and the lag between reduction in budgetary authority and actual spending. As a result some of the reduction in spending may come after 2021.
By 2021 we expect that the debt-to-GDP under the automatic cuts to be little different than our baseline, 72% and 73%, respectively. The current ratio is around 68%. Our analysis also continues to show that given implied forward rates, net interest to revenue ratio still suggests that the US should have little trouble meeting its obligations. In other words, US debt dynamics remain on a relatively stable path through to 2021. After 2021 entitlement spending should continue to be a key risk that should push these dynamics in the wrong direction.
The biggest impact on economic growth from the automatic cuts could be in 2013. The spending reduction in 2013 should be around $70bn versus our baseline of $34bn. While government should be a bigger drag on growth than we had been expecting, the difference is only 0.2% of GDP, suggesting the actual hit may only be superficial.
The failure of the committee also increases the risk that at least one credit ratings agency may follow up with a negative action. S&P seems the most likely candidate, as its rationale for the August downgrade to the US credit rating was due to mostly political considerations. The ratings agency was said it would be also looking very closely at the outcome of the debt super committee.
Societe Generale
Research & Analytics