Fiscal Contraction and Economic Expansion: The 2013 Sequester and Post-World War II Spending Cuts

When the post World War II government cuts were taking place, Keynesians predicted an economic bloodbath. While most mainstream predictions were for unemployment to jump to 14 percent in 1946 should the government dramatically cut spending and hand over resources to the private sector, some pundits had this measure rising to around 30 percent. In fact, despite government spending falling from around 42 percent of GDP in 1945 to under 25 percent in 1946 and under 15 percent in 1947, unemployment remained below 5 percent throughout the period.

This article has explored parallels between the post–World War II fiscal contraction and the fiscal contraction brought about by the Budget Control Act of 2011 and one of its creations, the sequester, which was implemented in March 2013. Like 1945, predictions by politicians, government forecasters, and the media were for a dramatically negative economic effect. The sequester was to cause GDP to grow 1.5 percent slower than would otherwise be the case, unemployment would rise to over 8 percent, and employment would fall by 1.9 million. Despite these warnings, nominal federal spending fell in 2012 and 2013—the first time the United States has seen two consecutive years of declining government spending in nearly six decades. And yet it turned out that GDP grew faster and the unemployment rate fell more quickly in the 18 months after the sequester went into effect than it did in the 18 months that preceded it. Once again, Keynesian predictions of Armageddon when government spending falls back toward its optimal level were shown to be wrong. The sequester episode provides further support the view that cuts in government spending toward their optimal level—around 17.5 percent of GDP—do not harm, but actually help, the economy.

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