Debt Ceiling Deal Could Threaten Economic Recovery

Will a deal on the debt ceiling stimulate or stifle the economy?

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Recent weeks have brought a slew of economic data signaling a slowing economy: weak GDP growth, growing unemployment, and today, news that the manufacturing sector is dangerously close to a contraction. While the nation breathes a sigh of relief that a debt ceiling deal may be close, a broader question still lurks: could lawmakers' compromise deal further jeopardize the nation's already anemic recovery? Economists differ on what will happen next as a result of the debt agreement, from slowing the economy even more to providing a more certain environment in which businesses spend and hire.

[Read about the nation's troubling economic growth figures.]

Putting the Brakes on an Already Sluggish Recovery

The deal does not contain any of the typical fiscal policy tactics that governments usually employ to counteract recessions: tax cuts and increased government spending on purchases and direct transfers to the public, like unemployment insurance.

Joel Naroff, president of macroeconomic consulting firm Naroff Economic Advisors, disagrees with the plan on this fundamental level. "The idea that increasing taxes cuts jobs but decreasing spending doesn't is silly," he says. Instead, a decrease in government spending is going to slow economic growth, worsening an already dismal national economic situation. "It's going to slow growth. If you have slow growth, you're going to have less hiring. In some parts of the economy, there are actually going to be layoffs." In particular, Naroff foresees further job losses in state and local government.

Peter Morici, professor at the Smith School of Business at the University of Maryland, believes that further economic pain awaits as well, but mostly because the deal does not address what he sees as key structural problems in the economy, like inefficiency in the healthcare system, which leads to increased government spending. "It's not going to make the present situation worse, but it's not going to alleviate the kind of problems that have caused the government to grow slower in each successive recovery. That's the problem," says Morici.

Getting the Economy Back on Track for Growth

The deal that Congress is considering does not increase taxes, and any supply-side economist would say that keeping taxes low stimulates growth, allowing people to spend their money as they will, rather than letting the government spend it. Furthermore, the deal addresses the very real long-term problem of U.S. debt, which is an unmitigated positive to Allan Meltzer, professor of economics and public policy at Carnegie Mellon University and visiting scholar at the conservative American Enterprise Institute. He adds that though many see the bill as flawed, it should be applauded for addressing long-term spending and a possible future crisis brought on by spiralling U.S. debt. "Nobody is going to say they think that we really got the right answer. But we moved in the right direction, and that's a plus. Look how long it took to get to this point. So we should be celebrating that we got there," he says.

Kenneth Rogoff, professor of public policy at Harvard University, agrees that, while the bill is imperfect, the debate brought a very important topic out of academia and into the public eye. "There is a silver lining, which is that a year ago, no one was talking about the unsustainable long-term trajectory except for economists," he says.

[See why corporate tax reform might soon be a reality.]

Extending the Uncertainty

A vast majority of cuts that the deal proposes will not go into effect next year, meaning that the deal's broader potential economic consequences will not be seen until 2013 or 2014. By then, a fresh crop of lawmakers in Washington could undo the deepest cuts before they go into effect.

Regardless of what future lawmakers might do, still unresolved is the question of whether the country will see the same fight on an annual basis. This is what worries Rogoff. "In my view, problem No. 1 is that it leaves so much unresolved," he says. "However it's packaged, it's fundamentally a temporizing deal that doesn't solve the longer-term problem not so much of the deficits but of how we do legislation in the United States." This political problem could have far-reaching consequences; as many warned in the recent debt-ceiling fight, even the threat of U.S. default could wreak havoc on the global economy.