A funny thing happened to our dysfunctional government. It functioned, unwittingly perhaps, but function it did. President Obama forced Republicans, unwilling to risk the political consequences of taking America over the fiscal cliff, to accept a $180 billion tax increase. Republicans returned the favor by forcing the president to live with an across-the-board spending cut—the sequester—that he had long-ago proposed, confident that Congress would never implement it. He guessed wrong. As a result of these tax increases and spending cuts, our government’s deficit is headed down. It was $1.1 trillion in fiscal 2012, will be about $845 billion this year, and fall to $615 billion in fiscal 2014, almost half the amount of red ink spilled in 2012. The deficit-to-GDP ratio is also falling, from 7 percent in 2012 to 5 percent this fiscal year, and to a reasonably acceptable 3.7 percent in 2014. The Treasury actually will be paying down debt in this quarter. Yes, April is typically a month of high tax collections, and the Treasury will resume borrowing in the next quarter. Still, this is the first quarter since 2007 in which the Treasury will pay off at least a few of our IOUs.
Republicans are unhappy that this touch of fiscal sanity has been purchased at the price of substantial tax increases, Democrats that it has been bought by cutting some of their precious spending programs, voters that the President has ordered his bureaucrats to maximize the pain of spending cuts and that their pay checks have shriveled as a result of the increase in payroll taxes.
Economists are guessing that fiscal tightening will knock between 1 percent and 1.5 percent off growth this year. The president and his followers argue that fiscal tightening should have been postponed until the economic recovery is less fragile. There is some sense to that argument, at least theoretically. But conservatives respond that Democrats will never believe the recovery is robust enough to stop borrowing to fund an expanding state. So better to get the deficit under control now, even if the sequester is a clumsy paring instrument.
Two developments support the cut-the-deficit-now crowd. The first is Friday’s jobs report. The private sector created 176,000 new jobs in April, and the initially reported February and March figures for total jobs created were revised upward by a total of 114,000 jobs. The revised February figure of 332,000 was the highest in almost 13 years, if we ignore temporary blips such as the addition of thousands of census workers in 2010. Better still, the number of long-term unemployed (27 weeks or longer) declined by 258,000. Not all of the data buried in this detailed Labor Department report are as encouraging—hours worked continue to drop—but all in all it provides more talking points for the deficit hawks than for the deficit doves. The deficit is plunging, and the jobs market has not weakened, at least so far.
The second development that makes fiscal tightening less worrisome is the decision of the Federal Reserve Board’s monetary policy committee to ride once more unto the breach. It will not only continue the current loose policy, but if necessary loosen further. It emerged from its two-day policy meeting this week to announce, “The Committee is prepared [this is new] to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes [italics added by me].”
There is more. With the Fed’s preferred measure of inflation hovering at around 1 percent, inflation fears that might have worried the Fed have abated. In addition, the Fed will not slow the presses if the unemployment rate falls only because workers in greater numbers give up the job hunt—if the labor force participation rate declines further, in technical jargon. In short, tighter fiscal policy will be offset by continued loose, or even looser monetary policy. That means the age of near-zero interest rates is far from over. The result:
· Continued easy credit for car buyers—which re-employed and more fully employed construction workers are using to purchase new trucks.
· Continued record-low mortgage rates that are driving sales of houses—both sales and prices are rising, each up over 9 percent compared with last year.
· Continued rises in share prices, as traders add chairman Ben Bernanke to their pantheon of heroes.