## Monday, January 20, 2014

### The effect of "the sequester"

After updating the model and doing some counterfactuals about quantitative easing and the fiscal stimulus, I thought I should do another counterfactual: the effect of "the sequester". The CBO estimated that it would shave off 0.6 percentage points of GDP growth and result in about 750,000 fewer jobs. Well, my top-line results indicate it shaved 0.4 percentage points off GDP growth and resulted in 730,000 fewer jobs. The basic methodology followed the first linked post above. Now, let's get to the graphs! The first one is the effect on NGDP (purple), shown alongside the "sticker price" (green):

The multiplier is again about 1.3, in line with IMF estimates of 0.9 to 1.7. There is a black dotted line that shows the effect of the sequester without the more aggressive monetary expansion that began at the beginning of 2013; the monetary expansion shaved off only $1.2 billion of the$71 billion change in NGDP. The effect on the number of people employed is shown in the next graph (734k fewer jobs at the end of 2013):

Again there is a black dotted line that shows the effect of the more aggressive monetary expansion in 2013. The \$1.2 billion in monetary offset results in 12,000 additional jobs. There would have been a total of 747k fewer jobs without the monetary expansion.

All of these effects are in line with the CBO estimates (actually including monetary offset makes the CBO estimates even better), so what does this mean for the broader debate about "austerity" and monetary offset?  Our results here show that monetary offset was only about a 2% effect relative to the fiscal effect. Scott Sumner claimed that market monetarism passed a test (set up by Mike Konczal via Paul Krugman) because growth in 2013 turned out to be a little better than in 2012. But really, we should have expected much larger growth since we are recovering from a recession (recessions tend to be followed by a brief spurt of above average growth as the economy returns to trend). A 2013 that's similar to 2012 when we've had the largest recession since the Great Depression represents a massive failure, and at least part of that failure can be blamed on "the sequester".

For completeness, here was the estimate of the counterfactual less aggressive monetary base (black) vs the actual monetary base (blue). I made the assumption that the change in the slope at the beginning of 2013 was an adjustment made by the Fed to offset the effects of the sequester. However it is likely that the counterfactual should be even closer to each other (not all of the more aggressive stance was due to the sequester), meaning monetary offset should be even smaller.