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Will the budget deal boost the economy?

December 23, 2013

For Americans weary of legislative gridlock and partisan finger-pointing, the recently enacted federal budget came as a pleasant surprise. The question now, Vanguard believes, is whether the deal is a precedent for further action that will clear away the lingering fiscal uncertainty and provide a much-needed boost to the U.S. economy.

Last week, the Senate followed the House in enacting a compromise to avert a repeat of the recent government shutdown. Though it falls far short of the broad long-term spending and revenue reforms sought by lawmakers on both sides of the aisle—and which Vanguard believes are necessary to ensure long-term economic growth—the plan creates a two-year fiscal framework that raises revenue and cuts the deficit without outright tax increases. President Obama is expected to sign the legislation.

"If Congress and the White House can finally make real progress toward bringing down both the annual budget deficits and the long-term structural debt, I believe that will go a long way toward easing uncertainty."

–Joe Davis
Vanguard chief economist

Ann Combs"No one in Washington would call this budget perfect, but the fact that both sides were willing to compromise is at least a step in the right direction," said Ann Combs, head of Vanguard Government Relations.

"Without commenting on the specifics of this agreement, the important thing from our perspective is that the threat of another government shutdown is off the table for the near term. And, hopefully, there's now a window of opportunity for Republicans and Democrats to take the next step and work together on essential structural reforms to the tax code and entitlement programs."

The Fed says it's time to taper

The budget agreement wasn't the only major economic news coming out of Washington in recent days.

On December 18, Federal Reserve Chairman Ben Bernanke unveiled plans to gradually scale back the Fed's aggressive stimulus efforts, reflecting confidence that the economy is finally beginning to find solid footing. Financial markets applauded the announcement, with both the S&P 500 Index and the Dow Jones Industrial Average posting major gains that day.

"There's a consensus that the economy no longer needs as much emergency stimulus as it did," said Joe Davis, head of the Vanguard Investment Strategy Group and the company's chief economist. "That the Federal Reserve is willing to begin tapering down its monthly purchases of U.S. Treasuries and other assets is ultimately a good sign, even if it causes some market volatility in the short term."

An "uncertainty tax" reduction?

Coupled with the budget agreement, the Fed's "tapering" decision may help shore up economic confidence throughout the country, Mr. Davis said.

Joe Davis"For several years, economists have been concerned that uncertainty over federal fiscal policy was acting as a major drag on growth," he said. "We believe this so-called 'uncertainty tax' has, at the margin, discouraged businesses from hiring and investing, kept consumers from spending, and subtracted significantly from GDP during the past decade.

"If Congress and the White House can finally make real progress toward bringing down both the annual budget deficits and the long-term structural debt, I believe that will go a long way toward easing that uncertainty," Mr. Davis said. "It could be, fundamentally, the best form of economic stimulus."

Recent good news notwithstanding, economic policymakers are confronted by a number of difficult questions.

For example, this spring Congress and the Obama administration will once again need to address the federal debt ceiling. Anxiety over implementation of the Affordable Care Act, or "Obamacare," continues to weigh on consumers and policymakers. And powerful headwinds still face the U.S. economy—high unemployment, volatile energy prices, and a still-sluggish housing market, to name a few.

"We're not out of the woods yet," Ms. Combs acknowledged. "The budget agreement and the Federal Reserve's tapering decision are encouraging, but there's still much work to be done on all of these fronts. We'll be keeping close watch."

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