Budget compromise will make U.S. government less of a ‘drag’ on economy

Budget deal has economy poised to grow at fastest rate since 2008 recession

WASHINGTON (AP) — Congress is on the verge of doing something it hasn't done during three years of partisan warfare: Passing a budget deal that won't likely hurt the economy.

The two-year spending plan the Senate is expected to approve Wednesday all but removes the threat of another government shutdown like the one that slowed the economy in October. Among other things, the agreement will roll back some of the automatic federal spending cuts that kicked in this year.

The result? Economists say the U.S. economy has a good chance to accelerate at its fastest pace since before the Great Recession struck six years ago.

Growth has plodded along at a 2.4 per cent annual rate so far this year. Bolstered in part by the budget deal, the economy is poised to expand 2.9 per cent next year, its healthiest pace since 2005, according to an Associated Press survey of economists.

“There was a lot of austerity in 2013,” said Michael Hanson, senior U.S. economist at Bank of America. “We should have a lot less in 2014.”

President Barack Obama is expected to sign the bipartisan compromise. The measure overwhelmingly cleared the House last week. On Tuesday, the Senate advanced the bill in a procedural vote, setting the stage for final passage.

The deal marks a sharp change from recent years in which partisan hostilities led to governance by crisis. Deals were struck between Democrats and Republicans only as the government neared an emergency. A last-minute deal in October, for example, removed the threat of a default on the national debt that could have triggered another recession.

The earlier budget deals helped shrink the deficit. But they've also squeezed workers and businesses by hindering growth. Higher tax rates, along with spending cuts, subtracted 1.5 percentage points from annual growth this year, according to the Congressional Budget Office. That's the difference between an economy limping along at 2.4 per cent annual growth and one accelerating at close to a 4 per cent rate.

With the new deal in place, economists estimate that the government will exert less of a drag on the economy. The drag on growth from federal policies should decline from 1.5 percentage points this year to 0.5 percentage point at the most, economists estimate.

The bill approves spending in 2014 at slightly more than $1 trillion, compared with the $967 billion mandated by the automatic spending cuts. It boosts spending by $63 billion over two years.

It replaces the spending cuts with longer-term savings, many of which don't accumulate for nearly another decade. Airline passengers will pay higher ticket fees, but the additional revenue won't come from tax increases. Deficits would rise slightly in 2014 and 2015.

The compromise could also spur businesses to hire and expand because they're no longer operating under the threat of another government shutdown. It also suggests that a compromise will be reached when Congress must again raise the debt limit in February to prevent a possible default. Just the appearance of two nearly implacable political parties agreeing on the first bipartisan budget pact since 1986 has increased hope.

“More significant is that there is a deal at all, as that should eliminate the risk of another shutdown,” said Jim O'Sullivan, chief U.S. economist at High Frequency Economics, who forecasts that the economy will grow 3.3 per cent next year largely as a result of less drag from the government.

The agreement could also make it easier for the Federal Reserve to scale back its purchases of $85 billion in bonds each month. The Fed program has been intended to lower loan rates to boost borrowing, spending and investing. But even as hiring has picked up, Chairman Ben Bernanke has been reluctant to slow the purchases until Congress settled its differences on the budget.

Economists said the additional spending from repealing some of the spending cuts should help growth. But some of the gains could be offset by the end of emergency unemployment benefits on Dec. 28. The federal program has extended benefits to 1.3 million people who've been out of work longer than six months. The program's expiration could hurt because the beneficiaries will have less money to spend on food, housing, clothes and transportation.

But on the whole, the budget deal is viewed as a net positive for the economy.

“For the first time in recent years in Washington, D.C., lunacy has given way to a baby step back towards sanity,” said David Kotok, chairman of Cumberland Advisors, in a client note.

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