On March 1, 2013 President Obama signed the executive order that put the 2013 Sequestration into effect. Budget Sequestration, first used in the Gramm-Rudman-Hollings Deficit Reduction Act of 1985 (GRHDRA), places an automatic spending cap on the federal budget. If Congress exceeds the cap through spending authorizations (remember, Congress authorizes spending in the US Government) automatic cuts take place. The total size of the 2013 Sequestration is $85.4 Billion.
From Keynesian Economics 101 we all know that Y = I + C + (X-M) + G, that is, national income is composed of expenditures on investment (I), consumption (C), the balance of trade (Exports - Imports, X-M) and government expenditure (G). Everything else being equal, a cut in G will reduce Y. Therefore, the 2013 Sequestration should result in a recession, that is, a drop in overall national income.
In the graph above, produced by Macroeconomic Advisers (a nonpartisan organization that uses a complex macroeconomic model of the US economy to generate forecasts), the annual percentage change in real GDP (think National Income divided by the aggregate price level) with and without Sequestration is displayed. The blue line shows that Sequestration knocks a few percentage points off real GDP growth for all of 2013 but afterward there is no lasting impact compared to the gradual reductions in government spending assumed in the baseline (the red line).
Essentially the graph shows that Sequestration (really, enforced Austerity) inflicts unnecessary hardship on everyone affected by it from the Defense Department to poor children in Head Start. This is an important point but it misses the bigger picture. The Right Wing has been arguing ever since the Great Depression in the 1930s that Austerity (cutting government expenditure) is the correct response to Depressions and Recessions. Their argument is that since government gets its income from taxation, any reduction in taxation will put money in everyone's pockets to be used to pull the country out of Recession. If the government spends through borrowing, the spending is taking money away from investment (I) so there will be no effects on national income (Y). If government spends by printing money this will create inflation and have no impact on real GDP.
There are many arguments that can and have been made against this reasoning (you can read these arguments in economist Paul Krugman's blog on the NY Times here). Let's assume for the moment that each position (Keynes vs. the Classics) is just a theory. Testing these two theories is not easy because it would require a macroeconomic experiment that no economist can run. I cannot simply cut aggregate government expenditure and see what happens. I can develop a model of the economy (such as the one developed by Macroeconomic Advisers), include government expenditure as an input variable, cut the level of this input variable holding everything else constant and see what happens. But, I am working with a model not the real economy and the model is subject to specification error.
In the $85.4 Billion 2013 Sequestration, however, we have a perfect natural experiment. Now we will finally get an answer to the major macroeconomic debate of the last 100 years. Unfortunately, we will not get this answer because political forces are working to muddle the experiment. The House GOP promises to limit the effects of Sequestration on Defense, Law Enforcement and Border Patrol. The old arguments about big government and excessive spending get put aside when arguably the most wasteful part of government, the Defensed Department, is facing cuts.
In what different Universe would we just run the experiment and settle the question once and for all? In the end, all that will remain is our ability to run counterfactual experiments with our models, experiments no one seems willing to accept.
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