What next for the US debt ceiling crisis?

In early December, US congressional negotiators came to an agreement on the Bipartisan Budget Act of 2013 (BBA). While the BBA is a very modest deal, it does provide relief from the spending sequester (automatic and draconian spending cuts) and will increase discretionary funding levels by $45 billion in fiscal year 2014 and another $19 billion in fiscal year 2015. This will be split evenly between defense and non-defense spending. Its impact on the economy will be noticeably positive, compared with a continuation of the sequester.

Without this bill, the fallback option would have been to pass yet another continuing resolution to fund the government at current levels. The result would have been a fairly savage $20 billion sequestration of defence funding this year. With the BBA, there will be no sequestration for the next two years, so long as congressional budget-writers stick to the $1.012 trillion cap.

Thus, Democrats will be able to restore some funding for domestic budget priorities, while Republicans can prevent deep cuts to the military. But the bill was not a complete loss for policy-makers, whose primary concern is the federal deficit. In exchange for the additional $64 billion in discretionary spending, the BBA includes cuts in mandatory spending worth $78.4 billion and increases in revenues worth $6.6 billion, for a total deficit reduction of $85 billion over the next 10 years. The net result is a purported deficit reduction of about $23 billion over the next 10 years. Of course, this is a drop in the bucket compared with the $5.7 trillion in deficits that has been projected for that time period.

The fiscal drag that plagued economic growth in the beginning of 2013 will be much less evident in 2014. But despite the higher funding levels, we don’t expect federal government spending to contribute to economic growth this year. This means that government spending will be a drag on GDP growth once again in 2014, but a much smaller one. Whereas government spending is expected to cut 0.4 percentage point from GDP growth in 2013, it is expected to cut just 0.1 percentage point from GDP growth in 2014.

Perhaps the most important aspect of the BBA is that the chances of repeating October’s government shutdown have virtually disappeared, removing a significant element of risk from the forecast. The BBA also suggests a spirit of bipartisanship that may make an agreement on raising or suspending the debt limit, with its 7 February deadline, more likely. The reduction of this risk also makes a January start to the Federal Reserve’s tapering process more likely (although still not certain).

Author: Nariman Behravesh is the chief global economist at IHS Global Insight and author of Spin-Free Economics: A No-Nonsense, Nonpartisan Guide to Today’s Global Economic Debates and is participating at the World Economic Forum’s Annual Meeting 2014 in Davos.