Greenspan called sequestration a “pretty much expected” event while concluding that if the stock markets can hold up through it, the effect would be “rather minor.”
During a CNBC interview on Friday, Greenspan was asked, “If [sequestration] does, in fact, take effect on March 1 and those spending cuts take place, what kind of an impact would you expect on the broad economy?"
Greenspan responded, “Well, I think the odds of it occurring are very high. In fact, and I find it very difficult to even think through a scenario in which it doesn't happen. The effect is not going to be horrendous, but it's going to be marked.”
“At the moment, I think the critical issue is how does it affect the stock market, and he reason for that is the stock market is the really key player in the game of economic growth at the moment, because there are two factors about stock prices, which I think, are important to understand. The first is that the so-called equity premium that is, the rate of return that equity is required is a very high number – close to the highest number probably in American history,” he said.
“This means that it's going to be very difficult to get stocks down through it. It's very much like saying the earnings-price ratio is at a level at which it cannot basically go down very much- I should say the price-to-earnings ratio can’t go down very much,” Greenspan said.
“And so 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 would be rather minor,” the former Fed chairman said.
Sequestration, as it is known in Washington, is the package of automatic cuts from both defense and non-defense spending that will go into effect next month unless Congress reduces federal spending by $1.2 trillion. The automatic cuts, agreed upon by both parties in 2011, will slash about $44 billion from the federal budget in 2013 and about $1 trillion during the next decade.