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11 22 2015 | by Victor Xing | Economics

Does fiscal austerity negate the effectiveness of QE?

Yes indeed, fiscal austerity does offset (but not completely negate) the effectiveness of quantitative easing.

The 2013 budget sequester went into effect on March 1 2013.  A total of 69,000 federal government jobs were lost over the following 21 months, an exceptional scenario given the growth of private sector job gain during that time.

Federal Reserve’s QE3 program officially began one day after the September 13th 2012 FOMC meeting, and it was concluded in October 2014.  Unfortunately, negative impacts from the budget sequestration persisted in the real economy despite the Federal Reserve’s unconventional policy measures.

Source: BLS data, aggregated and ranked by Victor Xing

Fiscal austerity and labor market impacts
Fiscal austerity and labor market impacts

Research by GS economists indicated the following impact of fiscal austerity (budget sequester) on U.S. GDP growth into 2014.

Drags from fiscal austerity
Drags from fiscal austerity

However, the true impact of sequestration went beyond economist expectations, and the impacts were still being felt into late 2014.  The Federal Reserve finally removed its language regarding fiscal headwinds in its October 2014 FOMC Statement.

Fiscal austerity concerns - finally eased as of late 2014
Fiscal austerity concerns – finally eased as of late 2014

Below is FED Vice Chair Stanley Fischer’s speech in August 2014: The Great Recession: Moving Ahead, highlighting fiscal headwinds on economic growth.

The stance of U.S. fiscal policy in recent years constituted a significant drag on growth as the large budget deficit was reduced. Historically, fiscal policy has been a support during both recessions and recoveries. In part, this reflects the operation of automatic stabilizers, such as declines in tax revenues and increases in unemployment benefits, that tend to accompany a downturn in activity. In addition, discretionary fiscal policy actions typically boost growth in the years just after a recession. In the U.S., as well as in other countries–especially in Europe–fiscal policy was typically expansionary during the recent recession and early in the recovery, but discretionary fiscal policy shifted relatively fast from expansionary to contractionary as the recovery progressed. In the United States, at the federal level, the end of the payroll tax cut, the sequestration, the squeeze on discretionary spending from budget caps, and the declines in defense spending have all curtailed economic growth. Last year, for example, the Congressional Budget Office estimated that fiscal headwinds slowed the pace of real GDP growth in 2013 by about 1-1/2 percentage points relative to what it would have been otherwise. Moreover, state and local governments, facing balanced budget requirements, have responded to the large and sustained decline in their revenues owing to the deep recession and slow recovery by reducing their purchases of real goods and services. Job cuts at federal, state, and local governments have reduced payrolls by almost 3/4 of a million workers, resulting in a decline in total government civilian employment of 3-1/4 percent since its peak in early 2009.

Next article11 21 2015 | by Victor Xing | Central Banks

Should the Federal Reserve follow Taylor Rule?