CHART: How More Austerity Will Push The U.S. Further Away From Full Employment

Our guest blogger is Adam Hersh, an economist at the Center for American Progress Action Fund.

The U.S. economy went negative in the last quarter of 2012, shrinking by 0.1 percent. That’s not good, and a big reason for the drop is Congressional conflicts over fiscal policy.

Uncertainty over fiscal policy and debt ceiling brinkmanship, according to forecasting firm Macroeconomic Advisors, are knocking 0.5 percentage points off the growth rate. What’s worse, though, is the actual contraction in fiscal policy already underway and the contractionary decisions about to be made in the next few months.

Public spending overall by all levels of government shrank by 15 percent in the fourth quarter, primarily due to defense drawdowns. Fiscal contractions put into effect by the American Taxpayer Relief Act and other tax policy resets at the beginning of January can be expected to cut as much as 1.3 percentage points from U.S. economic growth in 2013. If politicians allow the cuts in the so-called “sequester” to go ahead, growth will take another 0.6 percent hit.

Fiscal contraction is pushing our economy further and further away from the level of activity we need to reach full employment — that is, bringing the unemployment rate down to about 5 percent, shown by the red dashed line the graph below. The Congressional Budget Office estimates this level of “potential output” at full employment to be $14.5 billion, while fiscal contraction ground the U.S. economy down to $13.6 billion in 2012. In other words, until the blue line of actual GDP gets up to the red line, we will not fix our employment shortfall. The United States needs $900 billion more in economic activity to do this:

The good news is that there is no economic reason to impose fiscal contraction at this time. As economists at the American Enterprise Institute wrote, “An abrupt spending sequester…could cause a US recession, coming as it does on top of tax increases worth about 1.5 per cent of GDP enacted in January…[D]eficits have been, and will continue to be for some time, eminently sustainable.”