A Fiscal Cliff? More Like a Fiscal Slide…

Here’s a very good summary of the impact of the “fiscal cliff”.  Not that this isn’t a big deal, but it’s not a cliff so much as it’s a “slide”.  Either way, the lack of an agreement would have a big drag on 2013 growth even if it’s gradual.  More via the CPBB (thanks to Joe Weisenthal):

“The federal budget is expected to shrink dramatically between 2012 and 2013 if the laws governing revenues and spending remain largely unchanged.  With no action from policymakers, that sharp reduction in the deficit would slow the economy dramatically, likely creating a mild recession in 2013.

Even under that scenario, however, the economy will not go over a cliff and immediately plunge into another Great Recession in the first week of January.  Rather, most households will begin to receive somewhat smaller paychecks due to higher income tax rates and the expiration of the payroll tax cut, but the impact on their cash flow would play out over the year rather than being concentrated in January.  More important, there is bipartisan support for extending most of the middle-income tax cuts through 2013, so the impact of a temporary expiration of the tax cuts on consumer spending is likely to be modest, given the very high likelihood that lawmakers will end up extending them retroactively to January 1, 2013 if they haven’t acted by New Year’s Day.

The greater danger is that misguided fears about the economy going over a “fiscal cliff” into another Great Recession will lead policymakers to believe they have to take some action, no matter how ill-conceived and damaging to long-term deficit reduction, before the end of the year, rather than craft a balanced plan that supports the economic recovery in the short term and promotes fiscal stabilization in the intermediate and longer run.”


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • whatisgoingon

    If not the Fiscal Cliff, what do you see is the biggest risk on the horizon?

  • http://breedinginstability.com Mountaineer

    ‘Fiscal Slide’ seems like a far more accurate description. The real effects of the forthcoming budget battles should be visible in rising uncertainty and a decrease in the demand price for investment. Weakening capex numbers seem to support this.

  • Blobby


  • JK

    Hey Cullen,

    Would an attempt to cut the deficit be counter-productive… by causing less effective demand >> less employment >> more people needing unemployment compensation and welfare >> deficit goes back up due to automatic stabilizers?

    Also, what portion of our deficit is non-discretionary spending?


  • GreenAB

    thanks for the link Cullen!

    everyone should see table 1 for details.

    so the tax cuts would make 316b (or 56% of the total cliff).

    honestly i see no way how they could ever solve this without hurting the economy.
    the only way to minimize the impact would be to slowly phase the taxes back in. cut a definite agreement to raise those taxes by 60b over 5 years or so.

  • David

    I am down with MR, but one thing that has me puzzled about this new budget coming up is while I see the need for fiscal spending/tax cuts; don’t we eventually have to address the deficit? We go over this a lot on here, but I am one to think that size matters when it comes to all things money related. Yes, Japan is 220% debt/GDP and we are less than half that, but our total amount of debt is massive. Eventually this has to be tackled but I am unclear when. Growth will heal all wounds of course. Global wage presures are not letting up which has forced all types of problems for job growth at home here in the USA.

    It’s a pretty broad question but I just want to know at what point do we reduce government size(related to spending), is it once we see inflation move higher? I guess I should just focus on inventing the next internet to pull us out of this:)

  • Rich

    Your question is key. Once and if the USA returns to a so called normal growing economy, revenues (taxes)should also grow allowing the deficit to be reduced. This did happen in the Clinton administration. Unfortunately, most politicians seem to forget the part about paying down the deficit when things get better and instead continue to think of things to spend any surplus on in exchange for votes. The problem is the longer it takes for so called normal growth to return, the deficit grows to scary levels.

  • David

    I don’t want them to run a surplus though, a government surplus causes it’s own set of problems in a system like ours.

  • Johnny Evers

    Deficits create money. Paying down deficits destroys money. So if you’re down with MR, you have to free your mind from the idea that we have to pay back the debt. We can continually roll it into the future, safely, so long as our productive capacity grows.
    In the MR framework, the only check on deficit spending is that we spend too much and create more money that productive capacity, thus creating inflation.
    That’s my understanding. It makes sense; however, I’m not so confident that if policy makers adopt this view that we can restrain ourselves from creating too much debt.

  • Mikael Olsson

    Nit picking: Paying down on the deficit only partially destroys money – the part that came from new money. Which of course is a huge chunk so I’m not really disagreeing with the overall picture.

    What it definitely 100% does is put money back into hands that had too much money to begin with, so yes, the day-to-day economy most definitely contracts.

  • LVG

    Deficits don’t usually create money. They create net financial assets in the form of t-bonds. And surpluses don’t necessarily destroy money. They give the government more money to spend later. But the government doesn’t need to stockpile money so surpluses usually don’t make sense because they can always create money through their banks by borrowing later. Also, a nation that runs a current account surplus could run budget surpluses forever and be just fine. It’s only MMT that says budget surpluses are always bad. They’re wrong. See Scandinavia.

    I think you’re confusing some of the MMT descriptions with MR.

  • Johnny Evers

    But T-bonds *are* money, right? A T-bond is a liquid asset that you can sell any time, any day. That’s neutral for the bondbuyer, but positive for the taxpayer, who gets a check.
    And when we pay down debt, the taxpayer gives his dollar to the bond holder but doesn’t get anything back. That’s neutral for the bond holder, negative for the taxpayer.

  • http://www.orcamgroup.com Cullen Roche

    T-bonds are securities. Their moneyness is high, but not precisely like cash. The key to understanding how most treasury auctions work is understanding that the govt is mostly recirculating existing inside money and in the case of a deficit they’re adding a net financial asset in the form of a t-bond. Think of how you might buy a bond through Treasury Direct. For simplicity, you issue the govt a deposit of inside money, they issue you a bond, and they recirculate the deposit to someone else when they spend (no need to get into the tangled web of outside money settlement, etc – it’s not important). What’s happened there? No change in inside money. But a change in net financial assets because there is now a new t-bond. Do you have more spending power? Potentially. But you can’t spend the t-bond. You’d have to use it as collateral (in essence) to max out your credit cards or whatever. But in a balance sheet recession where credit expansion is weak, this has a rather muted impact compared to a non-BSR environment. Still, it makes the private sector balance sheet better off because it expands net financial assets. VERY important for a BSR environment and certainly a net positive in terms of repairing balance sheets.

  • David

    I’m not saying budget surpluses are always bad, but I think Scandinavia is a bad reference as they only have like 7 million people per country. Say what you will but I think this makes a difference. We could definitely improve our current account but I think running a surplus would be a stretch in the next 10 years, but not out of the realm of possibility. I guess my main issue is that our deficit spending over the last 15 years or so has not had that great of an impact on GDP or at least it’s not been as effective as it once was.

  • Johnny Evers

    Thank you.
    I like the concept of ‘money-ness.’
    Be interesting to see a scale of moneyness for various cash or debt assets!

  • Mikael Olsson

    Well running a surplus is how you pay back debt.

    But, yes, paying the debt back too fast can cause another recession if the money supply in day-to-day circulation stagnates.

  • Mikael Olsson

    Deficits definitely move money from nonproductive sectors to the everyday circulation. And that’s what matters.

    We can scrap the create/destroy bit and just accept that the everyday economy (including the state constitutes one system, and that the financial sector is, largely, a different system.

  • http://www.orcamgroup.com Cullen Roche

    Right, but the “create/destroy” myth is totally wrong. Govt spending recirculates inside money. It doesn’t create and destroy. That implies some sort of govt centric world similar to the idea of the money multiplier where the Fed ultimately creates all the money via its reserve maintenance. It’s totally wrong and largely derived from neoclassical mythology. We don’t have a govt centric monetary system. We have a private bank centric monetary system. So this stuff is very important to get right.

  • Mikael Olsson

    I’m pessimistic about the ability to run a surplus in the long term myself – at least as long as the USA is running a large trade deficit.

    Scandinavian countries run trade surpluses, and that is key, not the population size.

  • Mikael Olsson

    Germany also runs a major trade surplus and they’re on the same population scale as the USA.

    BUT their economy is also behaving a bit funny due to the East+West combination followed by the Euro experiment so it’s hard to glean extrapolatable insights from them.

  • Mikael Olsson

    Totally agreed!

  • David

    There’s just so many variables it makes my head hurt when I think of them all at once. I guess my point with Scandinavia is I think size does matter but I am just not smart enough to articulate that thought. Germany is an interesting case, but your right, the whole EUR experiment is a mess. I don’t really want a piece of that.
    I think one of the best ways to reduce our trade deficit would be throught the energy sector. We could slowly wittle it down by jacking up prodcution in the Dakota’s and the othe shales we keep finding. A trade surplus seems unreasonable due to how much supply chains have changed, but a smaller one is reasonable.

  • Mikael Olsson

    Or Gen4 nuclear reactors producing synthetic fuels. But that’s 15-20 year from mass production.