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Sequester 101: Is all this fuss really necessary?

The sequester spending cuts set to kick in March 1 address a serious long-term problem. But are they needed this year and in this way? No one thinks it's a perfect step.

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Recovery Act spending was large, but mainstream economists generally say the stimulus effort served a needed purpose, nudging the economy forward amid a deep recession.

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Overall spending, lingering above 22 percent of GDP, remains higher than average as Obama starts a second term. That’s partly because entitlement spending has continued to grow no matter who is president.

Perception: If there's a spending problem, it's with entitlements. Let's not cut discretionary programs.

Reality: Many budget analysts say that, although forecasts of future spending growth hinge heavily on entitlements programs, it's also appropriate to look for trims in discretionary spending. But they caution: spending on things like scientific research, transportation systems, and education often promote economic growth in the long run. So policymakers should ensure that needed investments aren't shortchanged.

Perception: Health-insurance costs aren't rising so fast, so future deficits may not be that bad.

Reality: It’s true that since the recession, medical costs have been growing at a slower pace of about 4 percent a year (compared with 7 percent previously). But health-care experts warn there’s no reason to think the cooler pace of price hikes in the health sector will become the long-term norm.

And even if it does, health care will still weigh on the federal budget. In the long run, health care looks to be the largest driver of fiscal challenges – and a 4 percent annual rise in costs is still faster than overall inflation. (Moreover, there’s the tide of baby boomers moving onto Medicare rolls to consider.)

Perception: We have to restrain spending now or the US could face a new financial crisis.

Reality: Financial forecasters don’t know when or if US fiscal policies will cause a financial crisis. Credit analysts have already downgraded their ratings of US Treasury debt, or warned that this could happen. Yet interest rates remain near historic lows – indicating that the US has no trouble finding buyers for its debt.  So there’s no clear hint of an imminent crisis, but also no guarantee the calm period will last for years.   

Perception: Bond investors aren’t dumping their Treasury bonds. The debt crisis is just a figment of fiscal-hawk imaginations.

Reality: This “don’t worry” argument is the questionable rebuttal to the “be very afraid” argument just discussed. Just because interest rates are low now doesn’t mean they will remain so. A more plausible view, taken by many forecasters, is that the US has window of opportunity – but perhaps a relatively short one – to address its fiscal problems. Failure could lead investors to conclude the US has no sustainable plan for servicing its debts.

On the comforting side, it’s possible that the nation’s debt-to-GDP ratio could remain stable for the next decade, if economic growth is solid and some budget adjustments are made.

But that’s no reason for complacency. That outlook doesn’t factor in uncertainties like possible recession or special national-security needs. And economists warn that the longer the US waits, the bigger the needed tax hikes or entitlement cuts will be.

“Beyond a certain level, debt is a drag on growth.” That’s the blunt message delivered in 2011 by researchers at the Bank for International Settlements (BIS), a multinational institution based in Switzerland. There’s debate about exactly where that threshold level lies, but the US may have already crossed it.

The BIS economists, led by Stephen Cecchetti, concluded that the danger zone for government debt is when it reaches about 85 percent of GDP. By their measure US public debt had reached 97 percent of GDP as of 2010.


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