As I noted yesterday, it’s not the threat of recession from the fiscal cliff that is despairing so much as it’s the CBO estimate that, even if the fiscal cliff gets put off, we’re staring at anemic 1.7% growth for 2013, and an unemployment rate remaining above 8% by the end of next year. This points to some serious problems with the US economy, and being the “best in the world” at a time of global slowdown is a cold comfort.
One of the reasons to expect such slow growth in 2013 is that CBO assumed some degree of fiscal consolidation next year. They’re right to assume it. Greg Ip at The Economist does a good job explaining the fiscal clifflet, a series of actions that are extremely likely to happen, even if Congress avoids the bigger threats out there.
Here’s the real threat. Even if the Bush tax cuts are extended and the sequester delayed, a huge amount of fiscal drag remains in place. They include the expiration of the payroll tax cut, the expiration of extended unemployment insurance benefits, imposition of a new 3.8% Medicare investment tax on the wealthy, and the bite to discretionary spending embedded in the Budget Control Act and prior continuing resolutions. ISI Group projects $220 billion of fiscal tightening in 2013, or 1.4% of GDP. JPMorgan, noting that many Recovery Act programmes are rolling off at the same time, puts the hit at a slightly higher $266 billion, or 1.7% of GDP. The IMF reckons fiscal policy will tighten more in America next year than in Spain, Italy or Portugal. Though smaller than the full fiscal cliff, the fiscal clifflet still poses a significant headwind to the economy. If enough other bad stuff is going on, it could push the economy back into recession.
I’m not sure all of this will actually hit – we might get an extension, at a somewhat lower level, of unemployment benefits – but the rest of it will in all likelihood happen. The Medicare taxes on the wealthy are part of the Affordable Care Act. The continuing resolution on the budget adheres to the spending cap from the Budget Control Act. And absolutely nobody in Washington is advocating for the extension of the payroll tax cut. So all of this will depress fiscal policy in 2013, and that’s without the Bush tax cuts or the automatic trigger cuts to defense and discretionary spending.
And I don’t think it’s credible that the Federal Reserve will somehow break with recent practice and provide the monetary accommodation to fill this gap.
The new President will have to face the challenge that he will preside over a bad economy in 2013. Neither of the candidates have offered anything in the way of a solution to this, at least not in the form of fiscal accommodation. In fact, both of them are more concerned with reducing deficits, at least rhetorically. As Greg Ip writes, “the age of austerity has begun.” And that’s bad news for Americans still trying to get up after being knocked down in the Great Recession.