February 3, 2013
LIA Monthly Economic Report: Fiscal Negotiations - What's at Stake?
By: Dr. Pearl Kamer
The biggest obstacle facing the U.S. economy is the uncertainty generated by forthcoming negotiations regarding federal revenues and expenditures. Suspension of the U.S. debt ceiling until May, provided that both chambers of Congress agree upon and pass a budget in that time, reduces the immediate threat of a federal default. Nevertheless, the stakes remain high. The nation is still struggling to recover from the recent recession. This is reflected in the fact that U.S. GDP contracted unexpectedly at an annual rate of 0.1% in the fourth quarter of last year and that only 157,000 payroll jobs were generated in January. As a result of this weak showing, the nation's January unemployment rate edged up to 7.9%. If budget negotiations stall and there is a real possibility of default, there could be a series of negative economic consequences lasting for years.
The current federal borrowing limit is $16.4 trillion. That ceiling was reached at the end of last year. Recent legislation would suspend the current cap on federal borrowing and reset it on May 19th to reflect the additional borrowing required through that date. At current rates of spending and taxation, federal receipts cover less than 74% of federal expenditures. This means that without additional borrowing authority the federal government must immediately cut its spending by about 26%. This is equivalent to 6% of U.S. GDP, enough of a reduction to cause another recession. There would be other serious consequences as well. A default would trigger more credit downgrades from the rating agencies. Standard & Poor's has already downgraded America's sovereign debt and the other rating agencies would follow suit. As a result, Treasury interest rates would soar, the value of the dollar would decline in global markets and stock markets could plunge. Some analysts believe that higher federal borrowing costs resulting from even a temporary default could persist for decades, leaving fewer resources for vital federal government functions.
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