Goldman Sachs: House Spending Cuts Will Hurt Economic Growth(Keynesian gloom and doom)

A confidential new report prepared by Goldman Sachs for its clients says spending cuts passed by the House of Representatives last week would be a drag on the economy, cutting economic growth by about two percent of GDP.

“Under the House passed spending bill [which cut spending by $61 billion],” says the report, which was obtained by ABC News, “the drag on GDP growth from federal fiscal policy would increase by 1.5pp to 2pp in Q2 and Q3 compared with current law.”

The report, which is signed by Goldman economist Alec Phillips, goes on to predict that the House-passed bill is unlikely to become law because it won’t pass the Senate and, in any case, the president threatened to veto it.

More likely, the report says, is a deal to cut spending by $25 billion this year, followed by a cut of $50 billion next year.

Even those more modest spending cuts, Goldman Sachs predicts, will cut economic growth rates by one percent of GDP.

•Proposals to cut federal spending, the possibility of a government shutdown, and the escalated debate over state employee compensation has increased interest in the effect of fiscal policy on growth, after last year’s fiscal package briefly neutralized the expected drag from federal fiscal policy. •Federal spending cuts deserve the most attention. They are the most likely of these issues to occur, and could have the largest magnitude. The assumption we incorporated into our recently revised budget estimates—discretionary spending cuts of $25bn and $50bn below the CBO baseline for FY2011 and FY2012 respectively—would shave nearly one percentage point off of the annualized rate of real GDP growth in Q2, but would fade quickly with a negligible effect on growth by year-end. •The related risk of a temporary federal government shutdown could also lead to a fiscal drag on growth, but this appears to be a lower probability scenario. We estimate that each week that the federal government is shut down would reduce federal spending by around $8bn, and could reduce real GDP growth by as much as 0.8 pp at an annualized rate in the quarter it occurred, but would provide a lift to growth in the following quarter as federal activity returned to the previous level. •The policies that several state governments are debating related to state employee compensation and organization appear to have—at least in the short term—little potential macroeconomic effect. We assume that state governments will cut spending or raise taxes no more than necessary to balance their budgets. This amount will be determined by the level of tax receipts available to pay for spending, not political negotiations. Fiscal drag is quickly reemerging as a focus, only a couple of months after an agreement to extend tax cuts and unemployment benefits appeared to have neutralized most of the drag from federal fiscal policy for most of 2011. We see federal spending cuts as the most important near-term risk. The possibility of a government shutdown is a significant but less likely factor, while the debate over state employee compensation seems unlikely to have a meaningful near-term macroeconomic effect:

Federal spending cuts would result in additional fiscal drag: In our recently updated budget deficit estimates, we have assumed that Congress will reduce discretionary spending by $25bn below the Congressional Budget Office's (CBO) baseline for FY2011, and another $25bn (for a total of $50bn below the baseline) for FY2012 (for more on these assumptions and our budget estimates, see “The US Budget Outlook: Better, but Not Good Enough,” US Economics Analyst 11/05, February 4, 2011). By contrast, the House of Representatives passed legislation over the weekend to cut spending for FY2011 by $60bn from current levels (the House hasn’t yet addressed FY2012). Both scenarios would add to the drag from federal fiscal policy on growth:

•The modest spending cuts we assume in our own budget forecast would lead to renewed fiscal drag. Since spending cuts could be enacted no earlier than next month, when the current fiscal year will be nearly half over, $25bn in cuts would require spending in the second half of FY2011 to be reduced by $50bn at an annual rate. Since the cut would be phased in abruptly, it could result in a drag on growth in Q2 by as much as one percentage point (pp), but would quickly fade over the next two quarters as spending stabilizes at a lower level, with little effect versus current policy on the rate of real GDP growth by year end. •The spending cut package that passed the House of Representatives would have a deeper effect. Under the House passed spending bill, the drag on GDP growth from federal fiscal policy would increase by 1.5pp to 2pp in Q2 and Q3 compared with current law. However, we don’t see this scenario as likely; while we expect discretionary spending to be cut, the current House proposal doesn’t appear viable in the Senate, and the president has already threatened a veto.

A federal shutdown poses less risk, as long as it is brief: A federal shutdown can potentially occur when one or more of the 12 annual appropriations bills have not been enacted for the current fiscal year. Usually, Congress provides temporary funding through a “continuing resolution” (CR) until appropriations have been enacted, but from time to time, particularly when control of government is divided, this does not happen and funding lapses. When this occurs, any agency or cabinet department without funding in place for the current fiscal year must cease non-essential operations. So far, Congress has not enacted any of the annual appropriations bills for the fiscal year that began October 1, so a shutdown would affect virtually all non-essential programs. That said, the potential for a federal shutdown probably does not present a major risk:

•While the possibility of a shutdown is real, it isn’t that likely. We wrote more extensively on the key fiscal developments over the next few months last week (see “The Federal Budget Process Gets Underway,” US Daily, February 17, 2011). The bottom line is that while rhetoric has escalated regarding spending cuts and the threat of a shutdown, we expect both sides to try to avoid one if possible, with the most likely solution appearing to be a short-term extension of funding at slightly reduced levels. •The effect of a shutdown is narrower than the term implies. Even in the most protracted government shutdown to date, from November 13 to 19, 1995 and again from December 15, 1995 to January 6, 1996, the majority of federal employees kept working. In the first episode in November 1995, about 40% of federal employees excluding the postal service were furloughed; in the December lapse the share of furloughed employees dropped to less than 15%, since Congress had managed to enact some appropriations legislation between the two shutdowns. If a shutdown occurred next month, it would probably affect nearly all agencies and departments, since no appropriations legislation has been enacted so far this year. But even so, this would imply that only around 40% of federal employees would be affected. •A shutdown lasting more than a week could be meaningful. If Congress fails to renew the continuing resolution that is set to expire on March 4, the lapse seems likely to be fairly short. After all, there have been several short government shutdowns over the last few decades, but only two lasting more than three days. But a lapse of more than a few days, particularly toward the end of the quarter, could be more important. If funding lapsed, non-essential services would shut down immediately, representing around $8bn per week in missed federal spending, assuming that 40% of federal employees (not including the postal service) and their activities are deemed non-essential. This would equate to $32bn in annualized terms, or around 0.2% of GDP for each week of shutdown. Pulling this spending out of Q2 would reduce the contribution to quarterly GDP growth from federal activity by a little over 0.8pp at an annualized rate for each week the shutdown lasted, though if the shutdown ended long enough before the end of the quarter it is quite possible that some of the missed activity could be made up, reducing the overall hit to growth. Otherwise, the return to previous spending levels following a one-week shutdown would actually increase growth in the following quarter by 0.5pp and by smaller amounts in subsequent quarters until most of the effect is reversed.

State budget negotiations seem likely to have the least effect: Debate over state employee compensation and the related issue of collective bargaining and other organizational issues among state employee unions have begun to make headlines in a number of states—Wisconsin, Ohio, and Indiana are the latest. While these issues are important for the longer-run fiscal health of state and local governments, in the short-term their balanced budget requirements make revenue shortfalls the most important factor driving their fiscal stance over the coming fiscal year (for most states, this begins in July). Political decisions will determine how spending cuts are distributed, and will also determine the mix of tax hikes and spending cuts, but are much less likely to change the overall amount of tightening that will occur. So while we continue to expect around 0.5pp in drag this year from state and local fiscal retrenchment, recent developments don’t seem likely to change this in either direction.

"What is written in the report ... There is nothing political in it, just well-established economics. It reflects no political motives or beliefs.

BS. It's socialism and that's both political and economic.

"I have not heard a repudiation of a positive observation, namely, that reduction in spending will reduce growth."

I believe that no one ever made such an observation. Growth refers to the entire economy's growth, not just that of GS, or any particular groups favored by those in power. Also, the spending relevant to the discussion is -PLEASE PAY ATTN- govm't spending of other people's money via govm't credit increases, on unproductive endevors. The only growth occurring, outside of what GSachs expects to take from their share of the redistributed capital, is in fiscal and total debt of the economy. That's a shrikage in GDP, not only for the present, but for the future also.

“Isn’t Goldman Sachs a bank that was part of creating this disaster?” Wasn’t Goldman Sachs former CEO they guy who helped President Bush set up the bank “rescue and bailout” program? Actually, a lot of this money has been repaid during the Obama years. Now the banks are just sitting on a lot of cash and not lending it for business/job creation.

Here is a link from Market Watch that points out that the latest bonuses are less than they were in 2007. That and 2008 were the peak of the bankster CEO salaries. In 2007 the CEO of Countrywide Financial had $140 million salary. In 2008 as finance began to tank he cut it to a paultry $100 million. In the same period Lehman Brothers almost doubled their CEO salary to over $70 million. By 2009 both companies were dead as doornails. On the other hand Goldman Sachs in the same period also increased the CEO salary to over $70 million. In fact in spring 2008 the top 3 executive of GS were paid over $65 million. Forty three % of their stockholders voted in favor of a Shareholders Advisory Vote on Compensation. [Forbes CEO Compensation site has lots of interesting data on this subject.]

http://www.marketwatch.com/story/wall-street-bonuses-declined-in-2010-2011-02-23?dist=bigcharts#

Last year after my GE stock plumeted from $50/share to $5, I was shocked to see that for the past 3 years the top 7 GE executives had salaries from $ 11 million to $22 million. Neither here nor above do the figures I quote include stock options, bonuses and perks. At any rate GE has been hovering between $15 and $20 for a year. We stockholders have to TAKE BACK OUR POWER. This spring many of us will receive Proxy documents with recommendations on how to vote for Proposals. Last spring, AGAINST managment’s advice, I voted FOR a STOCKHOLDERS ADVISORY VOTE ON COMPENSATION. I urge you all to do the same, before the government decides they have to do it for us.

"There is also nothing nefarious in an economist serving as a political analyst and then returning to economics. Some economists specialize in what is called social choice theory and some are well versed in politics."

Social choice theory-that's where big daddy gov., er um "the people" redistribute wealth to achieve a state of GSachs, er um "Pareto" optimality, as per the welfare clause.

"A confidential new report prepared by Goldman Sachs for its clients says...

Oh, bless their hearts! They're providing us "people" with free confidential reports! They're continuing their tradition!

Economists and others can argue forever about what “could have happened if”. If we look at the money spent (that we didn’t have) on the stimulus and take at face value the current administrations claims about the number of jobs saved and economic activity, the benefits fall short of the cost. In light of recent news that most of the money went to protect state or federal employees jobs and/or pensions, the actual benefits are a tiny fraction of the money spent, at the cost of an exploded debt.

“Looks like Zero’s “investment” in Sachs is paying off.”

Yes, and I frequently wonder about Warren Buffett. As I remember it, he invested 5 billions into GS during the 2008 financial crisis reportedly to demonstrate his ‘confidence’ in the future of America.

Did he know about the goings on between GS and the FedGov and simply want to join the party? Is that where his confidence came from?

What does that say about the railroad he bought (Norfork Southern, I think)? Is this supposed to be a beneficiary of Obama’s high-speed rail baloney?

Economists and others can argue forever about what “could have happened if”. I don't think there is any disagreement among the economists: if AIG were to go down after Lehman, there would a run on all major banks. I don't think there is an economist in the world who thinks there would another outcome in the absence of any action.

If we look at the money spent (that we didn’t have) on the stimulus...

I have never advocated or condoned the stimulus as it was promulgated. We appear in agreement here.

...and take at face value the current administrations claims about the number of jobs saved and economic activity, the benefits fall short of the cost.

I completely agree and more. In fact, we never had a stimulus package: what we had under that name was a reform package, one that changes the economy into a more statist (fascist) one. Roosevelt has done the same: under the guise of fighting the Great Depression and stimulating growth, he actually did everything to reform it. That is why there was not much growth; that is why the unemployment stayed over 16%. The "stimulus" jobs were distribnuted out of... offices of the Democratic Party (incidentally, it is since then Blacks vote 4 to 1 for the Dems; they voted at least 3 to 1 for the Republicans prior to that).

Same here: of the $800B only about $70B has any potential to stimulate the economy. The rest was disbursements to unions to ensure their future votes.

Just as in the case of Roosevelt, this administration does not wan to stimulate the existing, still capitalist economy; it wants to change it into something else. And is doing just that, to the cheering of the leftists and socialists among the "conservatives."

the report merely states economics fact

The report is someone at G&S's opnion, not fact:

•The spending cut package that passed the House of Representatives would have a deeper effect. Under the House passed spending bill, the drag on GDP growth from federal fiscal policy would increase by 1.5pp to 2pp in Q2 and Q3 compared with current law. However, we don’t see this scenario as likely; while we expect discretionary spending to be cut, the current House proposal doesn’t appear viable in the Senate, and the president has already threatened a veto.

Their opinion is that cutting government spending as proposed by the House will cut GDP by 2 percent. In other words, they ONLY way G&S sees to stimulate our economy is to have the government intervene. Not exactly a conservative ideology.

And the number of employees they have is irrelevant. It's the management and G&S that is doing this report. That was a silly argument.

the report merely states economics fact

The report is someone at G&S's opinion, not fact:

•The spending cut package that passed the House of Representatives would have a deeper effect. Under the House passed spending bill, the drag on GDP growth from federal fiscal policy would increase by 1.5pp to 2pp in Q2 and Q3 compared with current law. However, we don’t see this scenario as likely; while we expect discretionary spending to be cut, the current House proposal doesn’t appear viable in the Senate, and the president has already threatened a veto.

Their opinion is that cutting government spending as proposed by the House will cut GDP by 2 percent. In other words, they ONLY way G&S sees to stimulate our economy is to have the government intervene. Not exactly a conservative ideology.

And the number of employees they have is irrelevant. It's the management and G&S that is doing this report. That was a silly argument.

"Their opinion is that cutting government spending as proposed by the House will cut GDP by 2 percent. In other words, they ONLY way G&S sees to stimulate our economy is to have the government intervene. "

The word ONLY is the culprit here. It is plugged in solely by you. This is a false premise.

To most people versed in economics and/or physical sciences. The statement means the opposite: ceteris paribus --- all other things being the same --- the GDP would fall by 2%. The statement isolates the effect of a single variable: government spending. The degree of a drop is an opinion, but the direction of change seems to be a quite established fact.

No report would even try to make a claim as strong as you suspected. If it tried to say that other variable will never change or that we they would have no effect, those people would be laughed at and lose their jobs. Most juniors in college don't make that mistake.

I am sorry you misread the statement. If that is what you thought it said, your conclusions would be reasonable. The premise of your argument is unfortunately false, however.

And the number of employees they have is irrelevant. It's the management and G&S that is doing this report...

My remark about the number of employees had nothing to do with the report: it was a reply to a specific statement of another poster.

...That was a silly argument.

As you can see, it is helpful to ascertain at least what the argument was about before you use such strong characterization. Do you think it makes you look smart when you characterize something as silly while not even knowing the topic?

There were experts those who questioned Paulson's fears of a "systemic failure"

Of course there will be "experts" that would question Paulson's fears. Some experts make entire careers on doing just that: explaining after the fact, with the benefit of more informaton and hindsight, why your decision, made in real-time and with the benefit of limited information, was wrong.

People's actions can be judged only in view of the-existing circumstances and then-available information. But disregarding this fact is a way for some people to publish books and be visible otherwise. There will always be experts...

Here is an excerpt from the expert you cited:

While there is no denying that we are mired in a very serious financial crisis," Marenzi writes, "this does not yet appear to have been transformed into a general credit crisis. In aggregate, credit and lending markets appear to be functioning well, and in many cases are actually operating at historically high levels."

Mired, does not appear, appear to be functioning well... Blah, blah, blah...

He is even factually incorrect: credit has entirely froze at the time; banks were not lending regardless of the interest rates [ as you know, interest is the price of money, which depends on perceived risk; when banks think they face greater risk, they increase loan rates; they did not because they could not even estimate the risk ] Ironically, the only credit market that was still functioning at the time was the securitization market, which socialist propaganda tries to portray as the culprit of the crisis. But facts be damned.

So I don't know what time the author refers to here.

More importantly, when Bush and Paulson acted, they has a single objective: to prevent the runs on American banks, the runs that have already started to occur. They have already let go of --- Lehman. AIG was next, and there was no end in sight.

So compared that simple but harsh reality to the author's response: mired, does not appear, appear to be functioning well...

Thank G-d he only writes books and can do no other damage.

"choice theory and some are well versed in politics." Social choice theory-that's where big daddy gov., er um "the people" redistribute wealth to achieve a state of GSachs, er um "Pareto" optimality, as per the welfare clause. "

Spunkets, it's OK not to know something, but why do you insist on appearing like a complete moron? Why don't you at least browse the Web a little before you start spewing this nonsense and make yourself look ridiculous.

"A confidential new report prepared by Goldman Sachs for its clients says..."

You are not quoting me now, are you? This is from the article. Write that author to whine and complain about something (you are unsure of what to complain because you don't understand a word of it; but you are looking for something to whine about --- I am sure you'll find it).

"Oh, bless their hearts! They're providing us "people" with free confidential reports! "

It is clear that you are very angry but don't really know at what. Reports are confidential when they are sold to paying customers. It appears that the report in question is of that kind: experts at GS analyze the situation and issue their opinions, those that believe in their expertise and value their opinions (I know you are not one of them, you know better) pay for those reports.

The author of the article read it probably as stolen property. He, the author of the article and not the authors of the report --- now reveals that information to you. He has nothing to do with GS, but you appear to view the author of the articles and the authors of the report as one and the same.

You've got to think a bit more before you come to conclusions and especially before you voice those conclusions in accusatory form.

You can now take both feet out of your mouth.

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