The budget agreement reached by congressional Democrats and Republicans would provide only a modest boost to the U.S. economy. The psychological effect is likely to be a lot greater.
After a near default on the government’s debt in 2011, a 16-day federal shutdown in October, and plenty of political turmoil in between, Congress may finally be moving to ease the gridlock that has burdened the economy for three years.
The deal, which still must pass the House and Senate, is “a signal of a little less acrimony in Washington” before the next skirmish, raising the nation’s borrowing limit, said Michael Feroli, chief U.S economist for JPMorgan Chase & Co.
“Maybe it means we’re going to have a less bruising debt-limit battle and the bad vibes on fiscal policy won’t hang over the economy next year,” Feroli said.
The numbers in the accord are a small part of the nation’s $16.9 trillion economy. The agreement would ease automatic spending cuts known as sequestration by $40 billion in 2014 and about $20 billion in 2015 and set discretionary spending -- the government expenditures subject to yearly congressional review - - at $1.01 trillion this fiscal year.
Still, economists say the Dec. 10 accord may lift optimism. Standard & Poor’s chief U.S. economist Beth Ann Bovino said it “helps reduce some uncertainty from Capitol Hill and helps remove one of the roadblocks businesses and consumers face next year.”
“The private sector will probably be more confident when planning investment and spending for next year, which would directly boost growth,” Bovino said.
Sal Guatieri, a senior economist at BMO Capital Markets in Toronto, said the deal “could ward off political brinkmanship and fiscal policy uncertainty for at least a year, unleashing a wave of business investment and hiring.”
“The biggest downside risk” to the economy next year “has taken a big step back,” Guatieri said.
Wall Street’s biggest concern was that the agreement would remove the Federal Reserve Board’s worries about a political shock from Washington and prompt the central bank to begin reducing its stimulus for the economy. Fed officials have been debating when to start winding down $85 billion in monthly bond purchases designed to spur growth.
U.S. stocks yesterday sustained their biggest drop in a month on news of the deal amid speculation it would increase chances the Fed will decide to taper its monetary stimulus when it meets next week. The benchmark Standard & Poor’s 500 index declined 1.1 percent to 1,782.22 in New York. Stocks fell a third day today, with the S&P 500 declining 0.2 percent to 1,778.41 at 10:33 a.m. in New York.
Since the political focus in Washington turned from fiscal stimulus to deficit reduction with the arrival of the new House Republican majority in 2011, each year has brought a greater fiscal drag on the economy. It culminated in this year’s “fiscal cliff” of tax increases and automatic budget cuts.
Feroli estimates that deficit reduction curbed U.S. economic growth this year by 1.8 percentage points while less-dramatic austerity in 2014 will lower growth by 0.7 percentage point, including the impact of the current deal.
Even so, after all the previous political tumult in Washington, some in the financial community weren’t ready to incorporate the agreement in their plans since it may yet fail. The accord faces a vote as soon as today in in the House.
St. Louis-based Macroeconomic Advisers didn’t alter its forecast yesterday, said Joel Prakken, the firm’s chairman.
“Passage is not assured,” Prakken said. “Party leaders like it, many troops don’t. Hence, our wait-and-see attitude.”
The federal budget for the year retains some uncertainty with the debt limit set to run out as early as February. In the past, Republican members of Congress have attempted to use the legislation as leverage to win spending cuts.
Several economists interviewed by phone or e-mail yesterday estimated that, if passed, the deal would boost U.S. growth by 0.1 to 0.3 percentage point next year.
Before the agreement, economists expected U.S. growth next year to accelerate to 2.6 percent from 1.9 percent forecast this year, according to the median estimate of 67 economists surveyed by Bloomberg from Nov. 8 to Nov. 13.
Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania, said the deal will have “a small, meaningful but positive impact.”
“This is a reason to be a bit more optimistic that the recovery will kick into a higher gear in 2014,” Zandi said.