Congress’s Aug. 2 approval of a last-minute debt ceiling increase marked the beginning of at least a week of instability in the U.S. economy, which included Standard & Poor’s (S&P) downgrading the country’s credit rating, volatility in the stock markets and the Federal Reserve Bank’s announcement that it will maintain low federal interest rates.
American economists, including those at Stanford, have a variety of theories as to how the situation came to be, as well as how it will play out.
The flurry of economic activity began Aug. 2 when President Barack Obama signed the Budget Control Act of 2011 into law, hours before the U.S. was expected to default on its debt obligations. The law immediately extended the $14.3 trillion debt ceiling by $400 billion and gave the President the option of future extensions, subject to a vote by Congress. The debt ceiling could be raised by as much as $2.4 trillion total.
In return for the debt ceiling increase, the law mandated $917 billion worth of reductions in government spending in two parts over the next 10 years. $21 billion of these cuts will occur during the 2012 fiscal year and the remainder will materialize after.
The bill also created the Joint Select Committee on Deficit Reduction to suggest $1.5 trillion in spending cuts over the next 10 years. The committee of six Democrats and six Republicans, equally split between the House and the Senate, must make recommendations by Nov. 23.
If Congress does not approve at least $1.2 trillion in cuts by Dec. 23, reductions will automatically come from mandatory and discretionary funds in both defense and domestic accounts. Debate over addressing the deficit — whether and by how much to raise revenue through increasing taxes, and whether to reduce spending and by how much — accounted for Congress’ inability to produce legislation until the last moment.
Stanford economic experts have expressed differing views on the Budget Control Act.
“There were differences of opinion about whether spending limits should be associated with the debt limit increase,” said economics professor John Taylor Ph.D. ‘73. “The deliberation was over how to add cuts, which the Speaker said was necessary. The debate was also over whether taxes increased — Republicans did not want to have that.”
“The bill was definitely a compromise,” Taylor said. “It included things that Republicans wanted — like spending reductions — but not as much as they would have liked.”
Economics professor Gavin Wright believes that the Republicans have gained significantly from the act.
“The Republican party decided to use this as a sticking point for some of their agenda,” Wright said. “The majority of Republicans in the House felt ‘They’re not going to be able to do anything without us.’ They used the leverage they had to push through something that would not have had a chance of passing if it was initiated in the normal manner.”
“It’s pretty clear this is not a long-term solution,” Wright responded when asked about the scope of the bill. “The main drawback is that they’re calling for pretty dramatic spending cuts in the coming year . . . This seems not to be good public policy in light of the current economic situation. Ultimately, I feel confident that the economy will recover. It will be a long, slow recovery –<p>and I don’t think the implications of this budget are going to help that.”
Taylor agreed that the plan was imperfect.
“I would have preferred that it was laid out a little more carefully — without the two steps,” he said. “Other than that, it’s really what I hoped would happen. It’s not a complete solution — it’s a step toward a long-term solution. There’s more that needs to be done, like taking additional actions to reduce the deficit and growth of the debt.”
Financial Aid Ramifications
Despite the cuts, the bill increased funding for Pell Grants by $17 billion and protected the scholarships from cuts until 2013. Pell Grants have provided need-based grants to low-income undergraduates and some graduate students since 1995.
Under the Budget Control Act, graduate and professional school students will no longer receive federally subsidized student loans. The potential effect these cuts might have on the Farm remains to be seen.
“The loss of the interest subsidies for graduate and professional students will be effective for the 2012-2013 school year, so we still have time to consider alternatives,” wrote Director of Financial Aid Karen Cooper in an email to The Daily. “It’s too early to say how we might respond. Seventeen percent of Stanford undergraduates were Pell Grant recipients last year.”
U.S. Credit Ratings
On Aug. 5, S&P downgraded the U.S. credit rating from ‘AAA’ to ‘AA+.’ Neither Moody’s nor Fitch, which both also offer credit ratings, have downgraded the U.S. from its Triple-A status. Moody’s warned it may change the rating in the future, and Fitch is completing a review of its U.S. credit rating this month.
S&P explained the rationale behind its downgrade in a report.
“The downgrade reflects our opinion that the fiscal consolidation plan that Congress . . . recently agreed to falls short of what . . . would be necessary to stabilize the government’s medium-term debt dynamics,” the report said.
Chad Stone, chief economist at the Center for Budget and Policy Priorities in Washington, D.C. does not believe that the Budget Control Act influenced S&P’s rating change.
“I just don’t see the S&P downgrade as being something that can move markets,” Stone said. “Moody’s made a completely different call.”