"Kee" Points with Jim Kee, Ph.D.

In the U.S., the headwinds (negatives) of higher gas prices and the 2 percentage points increase in the payroll tax don’t seem to be influencing the economy too much as indicated by spending data and by the 1.1 percentage point increase in the manufacturing PMI and 0.8 percentage point increase in the non-manufacturing or "service" PMI (that’s “purchasing manager’s index” from the Institute for Supply Management’s February Report On Business). As the Wall Street Journal pointed out, that's probably because spending by higher income households is being buoyed by the “wealth effect” of higher housing and stock market values, which is offsetting the impact of higher gas prices and payroll taxes on lower income household spending.


Is it $85 billion or $42 billion? The stockmarket’s positive gains since Friday suggest that the spending sequester is not deemed by investors to be particularly impactful to the economy. “A collective yawn from all involved” is how the Financial Times described the reaction to sequestration. Perhaps that’s because the widely cited $85 billion in budget authority cuts (how much money agencies have permission to spend) is higher than the actual estimated cuts in budget outlays (how much they would actually spend this year) which is closer to $42 billion this year, or about one-fourth of 1 percent of GDP (Wall Street Journal; Congressional Budget Office). It’s complicated, but the rest of the $85 billion will be cut in future years, but attributed to this year’s budget. My award for the best description of this discrepancy goes to National Public Radio (NPR):


It’s kind of like your credit card. Your limit says you can spend $1,000, but you end up only spending $500. The difference is that once Congress gives agencies budget authority, they will spend all the money eventually – maybe just not in the same year that they were given permission to do so….It may take more than a year to build a bridge, for example, even if all the money to pay for it was approved in the first year…As a result, not all of the $85 billion would have been spent this year, even if sequestration weren’t to happen.”


The President and his economic advisor, Gene Sperling, describe the cuts as a “slow grind,” while several private sector research houses argue that when public sector consumption and investment falls, private sector spending tends to rise (e.g. H.C. Wainwright Economics, Inc.). Also, government operations run out of funding on March 27, and the House (Republican majority) is working on a bill this week to extend routine government funding through September – the so-called “continuing resolution.” The Senate (Democratic majority) is expected to take up the measure the following week.


Will Bernanke tighten? Federal Reserve chairman Ben Bernanke warned that tightening monetary policy too quickly would threaten the recovery and thus court more financial instability (so that answers that!). His speech at the Federal Reserve Bank of San Francisco is one of the clearest available on current and likely future fixed-income markets. It is well worth the 10-minute read, but might be a bit terse for non-economists.


And the most interesting two things I saw last week: University of Chicago economist John Cochrane wrote in the Wall Street Journal that the Treasury Department should seize its “once-in-a lifetime opportunity to go long” and replace its short-term debt (40% of Treasury debt rolls over every year, 65% in three years) with long-term debt. That’s so financing costs don’t swamp the budget as interest rates rise. Of course, writing a piece in the Journal doesn’t do anything by itself, but I’m glad to see this topic starting to get more play.