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After fiscal cliff, Sequestration - but what's in the name?

The US budget impasse is back on front pages again, only this time it has been given a fancy term: Sequestration. If you look that term up in a dictionary, you'll find its definition rather nonsensical given the current usage. "Sequestration" is typically associated with a legal process and has no relation with the economy whatsoever - well, at least until this year.



So what is sequestration in the recent context? In short, it is what remains of the "fiscal cliff" that we were dreading at the end of last year. Remember that the cliff was meant to end all fiscal stimuli, both on taxes and spending, and could potentially bring the US economy down to its knees once again.

The origin of the "cliff" and sequestration dates back to 2011, during the fiscal stand-off as Democrats and Republicans negotiated the US debt ceiling. An agreement was eventually reached on the more than $2 trillion fiscal savings over 10 years, in exchange for an increase in the debt ceiling.

Among them, around half were to be automatically imposed, starting from January 2, 2013, if the Congress could not find a plausible plan to reduce spending or raise taxes before that date.

The job was handed over to the so-called "super committee" to find an acceptable plan. Unfortunately, they failed to deliver, so we are left with the automatic cuts unless the Congress itself comes up with an alternative plan.

Fortunately, on the New Year's day, the US Congress passed the American Taxpayer Relief Act to extend most of the stimulus tax packages.

The Act also gave two extra months of breathing room for the decision on spending cuts.

But as anyone can guess, two months is not enough for politicians to avert what is clearly coming. As a last-minute effort, they frantically tried to push a couple of proposals during the last week of February through the Senate and Congress. Sadly, all got rejected and sequestration now goes into effect, trimming down Federal spending across the board by roughly 10 per cent or $85 billion for the current fiscal year.

As for our part, despite some media attention, the sequestration will have less of an impact this year. Back when the fiscal cliff was at its height, the necessary cuts were over $600 billion this fiscal year, which was strong enough to pull the US economy back into recession.

The current sequestration, however, is roughly 14 per cent of that cliff and will knock some digits of the US growth rate, possibly on a magnitude of 0.6 per cent, according to some estimates: Not a recession, but definitely a slowdown.

The real concern is for the longer-term outlook of the US economy. The drop in growth rate is not temporary, but over the span of at least 10 years in which the sequestration will take effect. And its impact will be more strongly felt in later years, once the fiscal sequestration translates through its negative multiplier effects.

In plain words, the US economy will grow more slowly from now on, or at least until the Federal government can come up with an alternative plan on where and how much it spends that is less harmful to the economy. If sequestration is such a worry, why introduce it in the first place? There is actually a good reason for this. Sequestration was designed as an incentive system for lawmakers in Washington to act more swiftly to deal with ballooning public debt and deficits. Without the sequesters, they reasoned, Republicans would deny any necessary tax increases to close the budget hole, while Democrats would refuse to take a serious look at all the earmark and entitlement programmes.

So all in all, sequestration is a nifty and witty law to force time-inconsistent politicians to become more responsible to a long-term reality during their short-term office. Thailand may find it useful to consider a similar tool during these extended periods of populist politics.

But of course, politicians themselves must offer a proposal on the sequestration. Who else would?

Views expressed in this article are those of the author and not of TMB Bank or its executives. Benjarong Suwankiri leads the TMB Analytics, an economic analysis unit at TMB Bank,

and can be reached at tmbanalytics@tmbbank.com.


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