Sequestration and the Government Shutdown of October 2013
Sequestration is a budgetary process in the United States under which limits on the federal budget are imposed. The process of sequestration involves setting a cap on the amount of spending that the government can undertake at any given period of time. The capping of the government spending is not a blanket one and it targets specific categories of expenditure.
Budgeting in the federal government of the United States is carried out through a process which involves both the executive and the congress. The executive arm of the government prepares a budgetary estimate of expenditures covering a specific period of time and the congress, which has an oversight authority over the executive on these matters, approves or disapproves these estimates. Through the appropriate appropriations legislation, congress approves the budgetary estimates submitted. This approval is not always automatic and the relevant congress committees discuss it and if necessary send it back to the executive with recommended changes to the executive, which is supposed to respond to these changes and make the appropriate changes. The appropriations legislation is only passed when there is an agreement from congress to the financial propositions of the executive. Once the legislation is passed, the spending that the federal government undertakes is lawful under the relevant appropriations law (The Budget and Economic Outlook, 2013).
Sequestration occurs when the spending provisions of the relevant appropriations legislation are exceeded. When this happens, a hard cap is set on the amount of government spending that can occur from that point on when the limit is exceeded. These caps are set on broadly defined categories and affect all the departments and programs under these categories equally. This means that some departments are not affected by the sequestration and these are usually critical departments such as national security and defence (The Budget and Economic Outlook, 2013).
The sequestration in 2013 was supposed to initially start on 1st January 2013 as a result of the Budget Control Act of 2013 which had reintroduced the sequestration process. It was postponed by the American Taxpayer Relief Act of 2012 which pushed the date of effect of the sequestration law to March 1 2013. The sequestration that occurred in 2013 was as a result of austerity measures meant to cut government spending between the years 2014 to 2021. In this envisioned plan to reduce spending, it is expected that an average of $ 238.6 billion reduction in spending will occur each year (The Budget and Economic Outlook, 2013).
The government shutdown which occurred between October 1 and October 16 2013 was as a result of the occurrence of the deficiency gap which resulted from the failure of the two houses agreeing on an appropriations resolution. Specifically, the Obamacare issue was the source of this disagreements, with the republican led House of Representatives refusing to approve the necessary legislation for its funding. This contest between that executive and the congress led to a budget impasse which led to the sequestration when the period covered by the previous legislation passed on September 30 2013. This led to the sequestration which occurred since at the beginning of October there was no appropriation legislation for use for the funding of the operations of the federal government. The sequestration was what was popularly known as the federal government shutdown. The shutdown occurred as a result of the sequestration which forced the shutdown of many government departments and programs which are considered non essential under the sequestration law (The Budget and Economic Outlook, 2013).
Fiscal policy generally deals with government revenue collection and expenditure in the influencing of economic processes. This implies that the most viable instruments that the government can use to control fiscal policy are taxation and control of government spending. Through controlling the changes in the levels of taxation on one hand and the level of government can influence macro economic variables in the economy to the levels that it desires (The Budget and Economic Outlook, 2013).
Sequestration is based on the concept of controlling the economic performance through the control of government spending. The law on sequestration, the Budget Control Act of 2011 is an attempt to rein the levels of government spending by having in place ceilings which control the debt levels. The Budget control Act of 2011 provides for the production of legislation by November that year that would facilitate the reduction of the spending deficit by $ 1.2 trillion dollars over a period of ten years. This did not occur because the committee tasked to produce such legislation failed to act, and this resulted into another budget control Act with into effect. This new BCA directed automatic cuts across government spending and split evenly between domestic spending and defense, taking effect on January 2 2013. The automatic spending cuts are the sequestrations (The Budget and Economic Outlook, 2013).
The sequester is based on two fiscal principles, the cutting down of spending and the limiting of the level of borrowing that the government can engage in. Though these intentions were well meant, the process and intention of sequestration has been taken hostage by opposing political interests pitting the Democrat executive and a Republican controlled legislature. This means that most of the economic principles behind the Budget Control Act of 2011 may have been lost in the political melee, and this is especially so after the committee which was tasked to come up with proper legislation of controlling the process failed on this task (The Budget and Economic Outlook, 2013).
For the last few years, the United States federal government has been operating on a deficit budget and using borrowing to plug in on the deficit. The level of deficit has been rising substantially and this has resulted in the deficiency of the aggregate demand of the economy. The implication of this deficiency in the aggregate demand is that the economy is operating below its full potential. In the year 2o8, the Real Gross Domestic Product of the United States economy fell by eight percent and has remained at a level which is approximately eight percent lower than the prerecession growth rate (The Budget and Economic Outlook, 2013). This deficiency in the aggregate demand has the effect of having about $ 900 billion in forgone goods and services in 2013 (Sullivan and Steven, 2003).
The deficiency in the aggregate demand means that there is a gap between the actual and potential level of output. This means that as long as this deficiency in the aggregate demand persists, there will always be a potential waste on the productive potential of the country. The deficit in the aggregate demand has resulted in the rise of the rate of unemployment in the country to 7.9% in 2013. It should be noted that this is the highest rate of unemployment that the United States has experienced since 1989 before the 2008 recession hit. The deficit in the aggregate demand has resulted in poverty rate of 30% in the economy. This level of poverty in the economy is higher than the average of the last three decades (The Budget and Economic Outlook, 2013).
The effect of the deficit in the aggregate demand does not only affect the potential levels of output compared to the actual levels of output. If not rectified, a persistence of this deficit is likely to have adverse long term effects on the performance of the economy. A continuation of the deficit in aggregate demand in the economy is likely to result in the erosion of the risk taking capacity in the economy, and this is likely to result in high interest rates since players will require higher premiums for their investments (The Budget and Economic Outlook, 2013). The aggregate demand deficit will also in the long run result in slower growth due to the economy’s reduced capacity of taking risk and the resultant forgone investment (Sullivan and Steven, 2003)..
The sequestration is intended to cure this deficit in aggregate demand. Its intention is to reduce government borrowing and thus deal appropriately with the budgetary deficit which results in the deficit in aggregate demand. In essence, the policy of sequestration is a contractionary fiscal policy. In the current situation where there is a high rate of unemployment, relatively low inflation and slow growth in the gross domestic product, a contractionary policy may not be the best course of action. In this situation, a contractionary fiscal policy is likely to have contractionary effects of the economy. Cutting spending, as envisioned in the sequestration law (Budget Control Act of 2011) would result in a further reduction in aggregate demand, reduce job creation and slow down economic growth. Such a fiscal policy will be indeed detrimental because to reverse such an economic decline would require an expansionary fiscal policy which would be the opposite of what the sequestration law calls for (Sullivan and Steven, 2003).
These fiscal policies are meant to operate in the short term. “In the short run (within a period of one fiscal year), output can differ from the natural level (yf). Thus, short-run equilibrium can occur at a level of output that differs from the natural level. Graphically short-run equilibrium occurs where the aggregate demand curve crosses the short-run aggregate supply curve. The left panel of the diagram below shows a short-run equilibrium in which output exceeds the natural level and the right panel shows a short-run equilibrium where output is less than the natural level” (Sullivan and Steven, 2003).
INFL MRAS SRAS INFL MRAS
SRAS’ SRAS
INFL2 EMR ESR SRAS’
INFL1
INFL1 ESR INFL2 EMR
AD AD
yn y1 y y1 yn y
As indicated in this graphical representation, a cut on spending can only result in the reduction in the economic growth (Sullivan and Steven, 2003)..
Since the economy is suffering from the effects of recession, an expansionary fiscal policy is required for recovery. The results of an economic recession occur because aggregate demand is decreasing or is too low resulting in production falling below the natural level, as illustrated below (Sullivan and Steven, 2003).
INFL
MRAS
SRAS
INFL1 E1
AD
y1 yn y
Policy goal: Increase aggregate demand. Policy action: Expansionary Fiscal Policy
The policy objectives behind the BCA are ill advised during this period when the economy is trying to recover from the adverse effects of recession (Sullivan and Steven, 2003).
Type of monetary policy the Federal Reserve currently practicing and monetary policy tool(s) being used
Monetary policy is usually employed with the intention of controlling money supply in the economy, usually to influence the rate of interest to promote economic growth and stability. The current monetary policy of the Federal Reserve is based on the premise that it should have the effect of fighting the impact of the recession in the economy. This expansionary monetary policy is expected to reduce the rates of interest prevailing in the market and thus combat the high rate of unemployment and inflation (Bernanke, 2006).
The current monetary policy that is currently being undertaken by the Federal Reserve is the reduction of the interest rates through the sale of government bonds. It has been proposed that the Federal Reserve buys bonds worth $ 85 billion in the current financial year. This is expected to increase the money supply since by the purchase of these securities the reserve is letting out high amount of money into circulation. The increase in the level of liquidity as a result of the sale of securities means that the cost of borrowing reduces in the short term as interest rates reduce (The Budget and Economic Outlook, 2013). The primary goal of the purchase of market bonds currently being undertaken is to reduce the prevailing interest rates. The secondary goals, which are usually more important, are for the low interest rates to trigger an increase in investments which would increase the rates of employment. This is the policy which informs the current policy being undertaken by the Federal reserve of buying securities in the form of bonds from the open market (Bernanke, 2006).
The monetary policy that is being practiced by the Federal Reserve currently is the open market operation. This involves the purchasing or selling of securities in the open market with the intention of expanding or contracting the money supply in the economy. Through the selling of securities in the open market, the reserve is able to reduce the level of money supply and thus increasing the interest rates that are prevailing in the economy at that time. This results in the reduction of investments and if not well controlled may result in increase in unemployment. This measure is usually used when the Federal Reserve intends to reduce high levels of inflation since a reduction of the money supply usually achieves this goal. The purchasing of securities by the Federal Reserve in the open market is usually intended to increase the level of money supply in the economy. Increase in the money supply in the economy has the primary objective of reducing the interest rates that are prevailing in the economy and by extension reduce the rates of unemployment (Bernanke, 2006).
Conclusion
The sequestration is meant to affect the fiscal policy of the United States and not the monetary policy. Though the monetary policy currently being implemented by the Federal Reserve is well informed and based on sound economic principle, the same cannot be said of the Budget Control Act which seeks to contract the economy. Its implementation should be subjected to further scrutiny so as to change so that the contractionary fiscal policy is done away with, seek other methods of dealing with high debt levels and seek methods of cutting spending over time without the adverse effects of rising unemployment and slowing economic growth.
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