Tags: Greenspan | cuts | sequester | economy

Greenspan: Sequester Cuts Won’t Be ‘Horrendous’ for Economy

By Dan Weil   |   Friday, 15 Feb 2013 06:56 PM

Image: Greenspan: Sequester Cuts Won’t Be ‘Horrendous’ for Economy
Former Chairman of the U.S. Federal Reserve Bank, Alan Greenspan (AP Photo/Alastair Grant)
Former Federal Reserve Chairman Alan Greenspan believes automatic spending cuts, also known as the “sequester,” will begin as scheduled on March 1 and will have an impact on the economy.

Spending reductions of $85 billion are slated for March 1 through Sept. 30. “I find it very difficult to even think through a scenario in which it doesn't happen,” Greenspan tells CNBC.

“The effect is not going to be horrendous, but it's going to be marked,” Greenspan says.

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The crucial issue is how the sequester influences the stock market, because “the stock market is the really key player in the game of economic growth at the moment,” Greenspan says.

“The data show that stock prices are not only a leading indicator of economic activity, they are a major cause of it,” Greenspan said

The equity premium, which represents the amount by which stock-market returns exceed risk-free returns, is probably at a record high. “This means that it's going to be very difficult to get stocks down,” Greenspan says.

“What you have to do here is to find a way to get through this particular pretty much expected event which will have a negative effect on the economy. But if the stock market can hold up through this, I think the effect will be rather minor,” Greenspan says.

The wealth effect of the stock market, which has risen to five-year highs, explains why the consumer has been able to overcome various headwinds, such as the payroll tax increase, Greenspan says.

As for the budget, small spending cuts won’t do, he says. “I think the problem is so severe at this stage that unless we come to grips with it in a large way, we're running into very serious trouble,” he states.

“I don't want to say that small cuts here and there won't help, and I don't want to say that the crisis is sitting right over the edge of our nose, but this is a wholly unsustainable type of events that are playing out there.”

Some people think cutting the $1.1 trillion budget deficit will be easy, Greenspan says. But nothing could be further from the truth. “We have picked all the low hanging fruit,” he says.

The graying of the baby boomers only makes matters worse, Greenspan says. “I don't think we've fully understood how big a deal this is.”

The fundamental budget issue is entitlements, as both Republicans and Democrats, acknowledge, he says. Greenspan sees great merit in the proposals of the Simpson-Bowles deficit reduction committee. “For a while I thought everyone was climbing on board, but that is not the case. This is wholly a political issue.”

When it comes to the sequester, some others aren’t as sanguine as Greenspan. The Bipartisan Policy Center, estimates that the spending cuts would eliminate at least 1 million jobs in 2013-14. And the Congressional Budget Office forecasts that as many as 1.4 million jobs could be lost.

“With the economy teetering on a knife edge, it is clear that this is the worst moment to initiate an indiscriminate budget cut,” according to a New York Times editorial.

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