Making Sense of the Fiscal Cliff

by David Gerlitz on July 27, 2012

Recent news reports make mention of the “Fiscal cliff” the US is approaching at the end of 2012. But just what is the fiscal cliff, and what are the ramifications of running off it?  Here’s the definition from About.com:

“Fiscal cliff” is the popular shorthand term used to describe the conundrum that the U.S. government will face at the end of 2012. U.S. lawmakers have a choice: they can either let current policy go into effect at the beginning of 2013 – which features a number of tax increases and spending cuts that are expected to weigh heavily on growth and possibly drive the economy back into a recession – or cancel some or all of the scheduled tax increases and spending cuts, which would add to the deficit and increase the odds that the United States could face a crisis similar to that which is occurring in Europe.”

So there you have it.  The fiscal cliff is tax increases and spending cuts which will slow the economy.

Either that, or the fiscal cliff is an extension of current policy which will result in an unwanted increase in government budget deficits.

This is a pretty nice piece of cognitive dissonance.  The fiscal cliff is a choice between two undesirable results.

We can understand why policy makers wouldn’t want to slow the economy any further through tax increases and spending cuts.  We are coming from 18 consecutive quarters of sub 2% growth. Pretty tepid.  In fact, a little more growth couldn’t hurt.

So it’s been stated that tax increases and spending cuts slow the economy.  If that’s so, then doesn’t it stand to reason that appropriately targeted tax cuts and/or spending increases would speed the economy?  Each side has its preferred method, but in essence, yes.  Tax cuts and spending increases raise the government deficit and put more wealth in the hands of the private sector, which would likely speed up growth.  That’s an unstated piece of the puzzle.

Which brings us to the 2nd part of the equation:  increased deficits may speed up growth, but they’ll also increase the risk that we’ll end up like Europe.   I’ve talked about this before.  For background, see my post:  What is Monetary Sovereignty?  It pretty well blows up the myth that we’ll turn out like Europe.  The point of that post is that the US controls its currency in ways that the Euro treaty doesn’t allow the Euro-nations to control the Euro.  They are more akin to US states like California than sovereign nations.

So in order to believe that we’ll have a crisis of European proportions, you have to believe that a little more growth through government deficits will cause us to go from all-time low interest rates to all-time highs in the blink of an eye, despite having a completely different currency system than Europe. It just isn’t going to happen.  What’s more likely to happen is that the fiscal conservatives and policy makers who decry deficits will take us from a disinflationary policy to one which is downright deflationary.  Keep your eye on this story to see how the 2013 economy may go.

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