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Don’t Underestimate the Economic and Financial Effects of the Sequester: Nouriel Roubini

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The stock market suffered its worst day in three months Wednesday after minutes from the last Fed meeting suggested the central bank could slow its asset purchases which have helped keep rates low and stock market prices high. Today stocks are down roughly 0.50%.

Economist Nouriel Roubini of NYU’s Stern School of Business tells The Daily Ticker that it’s not only monetary stimulus by the Fed that’s been driving stocks higher but also “more unconventional monetary policy” from the ECB, Bank of Japan, Bank of England and the Swiss National Bank. That stimulus is aimed at boosting economic growth and it may have helped, but the global economy is slowing.

In the fourth quarter, the major economies of the U.S., U.K, Japan and the Eurozone all contracted and they could slow even more because of spending cuts, says Roubini. “The core of the Eurozone has to do it, the U.S. has to do it…and when you have synchronized fiscal contraction the negative effects on economic growth are worse."

He’s forecasting 1.6% GDP growth in the U.S. this year, which would be the slowest pace in three years. On the positive side he sees growth in housing manufacturing and energy production, primarily the “shale gas revolution.” On the negative side: big government budget cuts.

“We believe we will go into sequester so the fiscal drag could be something like closer to 2% of GDP” which will be offset by some positive factors.

Roubini says the market should not underestimate the impact of the sequester cuts. “It doesn’t look like there will be a last minute deal on the sequester ….the question will be how long the sequester will last.” If it continues to many months, says Roubini. “The fiscal drag will be another 0.7% or 0.8% of economy” which could lead to another shock in the financial markets and another rating agency downgrade.

In the latest game of chicken [between the Republicans and Democrats] Roubini says the advantage has shifted to Republicans. “At the time of the fiscal cliff all the bargaining power was with the Democrats because the automatic stuff was the tax increases. This time the automatic stuff is the spending cuts” which gives the Republicans the upper hand. He expects they will continue to try to force Democrats to accept entitlement reform.

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