The U.S. has a deficit problem, and it needs to be fixed. But cutting spending and raising taxes will restrain growth: instead of that additional money stimulating the economy, it will be used to pay down debt. We're already beginning to see this at the state and local level, with ugly consequences shown earlier. What will federal government austerity look like?
Here's a chart created by economists at Societe Generale:
This assumes a $4 trillion, 10-year austerity plan, which is in the ballpark of numbers being discussed in Congress and by the deficit commission. According to SocGen:
The size of the cuts would be a major drag on growth beginning 2013. If Commission's plans were adopted: cumulative austerity measures from 2012 to 2015 should amount to around $900bn (size of necessary fiscal adjustment increasing each year). Growth and the fall in the unemployment rate would be restrained. Fed would have to lean against the fiscal winds to keep the recovery moving. Inflation and unemployment still undershooting Fed's targets by 2015 under the austerity scenario. Fed would have to lean against the wind to achieve its dual mandate. Austerity measures necessary. But may be quite painful."
There's no avoiding some degree of austerity, as the U.S. simply can't remain forever on the budget path it's been on over the past couple of years. But whatever plan is eventually agreed upon needs to be heavily back-loaded. If cuts are too deep too soon, the recovery could be killed off entirely and another recession would be upon us.
But even if the timing of this plan is impeccable, and it's properly back-loaded, relatively low rates of growth will be unavoidable over the next decade. The result will likely feel a lot like stagnation and certainly won't feel like a healthy, vibrant economy.