The deal between President Obama and Congress to raise the federal debt ceiling would avert a financial crisis but also threaten to aggravate the basic problems facing the U.S. economy, including a stubbornly high unemployment rate and weak demand.
The agreement could immediately lift the cloud of uncertainty over the economy. It would end a political stalemate that could have caused the United States to default on its obligations for the first time. Over the long term, the deal could help free the nation from what is fast becoming a crushing debt.
But, many economists say, the agreement could endanger the anemic economic recovery — because of both what the deal includes and what it doesn’t. The government would cut back on spending, which has softened the blow of the slowdown, while failing to renew measures, such as a payroll tax cut, that have put money in consumers’ pockets.
The debt deal represents a striking reversal from a year ago, when jobs were atop the government’s agenda and both parties were arguing over who had the best plan to increase employment. But even as the agreement threatens to tamp down growth this year and next, it doesn’t go nearly as far as financial analysts and some senior officials had hoped toward reining in the national debt later this decade.
In short, some economists warn, deficit savings are too modest in the future and too severe in the present.
The agreement would mean the government has less money to provide employment opportunities for the 9.2 percent of Americans looking for jobs. It would probably cut aid to states, whose own cuts are contributing to the weak economy, and eliminate at least $350 billion from the defense budget, prompting layoffs at government contractors.
Americans would also have less money to spend next year because the president failed to persuade Congress to extend a 2 percentage-point payroll tax cut and unemployment insurance. Obama has frequently cited those measures, put into place in December, as important in offsetting sharply higher fuel and food costs.
“Why would you want to impose restraint on an economic recovery that’s already fragile?” asked Josh Feinman, chief global economist at Deutsche Bank Advisors. “You’re removing spending power from the economy at a time when it needs it. That’s likely to make the economy weaker.”
Feinman added that a slowing economy would actually set back efforts to curb the debt. “If the economy gets weak, the budget gets weaker, because tax revenues are going to slow,” he said.
The latest sign of the slumping economy came Monday, when a key report on U.S. manufacturing showed fresh signs of weakness. The U.S. stock market, which was up on the news of a debt deal, immediately erased the gains after the report came out, ending the day slightly down. Yields on Treasury bonds have also remained low, partly reflecting investor concerns about the health of the economy.
The economy has been losing steam all year, and job growth has essentially stalled. Under these circumstances, most economists warn against cutting government expenditures when the private sector is not spending enough. Many economists have called for additional federal spending to stimulate growth.
The budget deal tries to address these concerns by keeping spending cuts relatively modest at first — about $25 billion in 2012 and $47 billion in 2013 — before making much deeper reductions in the following eight years. “To the extent that all these cuts happen in a year or two from now, that eases the worry about a sluggish economy,” said Ray C. Fair, an economist at Yale University.
But these cuts will still have an impact, trimming 0.2 percentage points from economic growth next year, according to IHS Global Insight, an economic research group. That could be significant in an economy that grew only 1.3 percent in the spring, not enough to generate many jobs.
The budget agreement calls for savings across government. The reductions would increase pressure on states and localities, which are a major recipient of federal spending and are struggling with their own difficult finances. A Goldman Sachs report last week said cuts by states and localities are a primary reason that the economy remains weak.
“Even with the anticipated levels of federal support, they’re having to lay off teachers and do less in a whole lot of areas, including public safety,” said James R. Horney, a senior policy analyst at the Center on Budget and Policy Priorities. “If we cut back on the funding we send to them, they’ll have to dig that much deeper.”
It will be up to lawmakers to decide specifically where savings will come from — aside from the one area explicitly targeted in the deal for cuts: student loans for graduate students. Over the next 10 years, the agreement would save nearly $1 trillion in defense and domestic spending, which excludes Medicare and several other programs, and empowers a congressional committee to find an additional $1.5 trillion in savings.
Obama and congressional Democrats say they will fight to extend the payroll tax cuts and unemployment insurance. The measures provided $150 billion of economic stimulus in 2011. Their expiration would represent a far greater drag on economic activity than the spending cuts proposed for 2012. J.P. Morgan Chase estimates that it would, in combination with cuts, trim 1.5 percentage points from economic growth next year.
The president “will make the argument that it is absolutely essential to continue to put extra money in Americans’ pockets as they deal with high energy prices and high food prices next year,” White House press secretary Jay Carney said.
Business leaders said the deal to raise the debt limit would dispel the uncertainty hanging over the economy. Thomas J. Donohue, chief executive of the U.S. Chamber of Commerce, said the agreement would help “restore economic growth, reduce spending, and create millions of new jobs.”
Although the proposed cuts are significant, the deal falls short of the minimum of $4 trillion in savings that analysts say is necessary to tame the debt by the end of the decade. Standard & Poor’s, the credit-rating firm, has threatened to downgrade the United States if Congress cannot trim at least that much from the budget over 10 years.
“We believe that this tentative agreement on a fiscal package and the U.S. debt ceiling will keep the possibility of a near-term rating downgrade alive,” analysts at Barclays Capital said Monday in a research note. “It represents, in our view, just a band-aid approach on the way to more sustainable public finances.”