GOLDMAN’S “FISCAL CLIFF” SCENARIOS
By Walter Kurtz, Sober Look
As discussed earlier this month, the US is facing a “fiscal cliff”, a sudden expiration of tax breaks and spending programs that could have severe consequences for the fragile US economic growth. The issue is now getting some attention in the media.
CNBC: – The United States’ economy could shrink as much as 4 percentage points in the first half of 2013 if Congress fails to address the expiration of $600 billion worth of tax breaks and jobless benefits by the end of this year, according to Goldman Sachs.
In a report issued on Tuesday, Goldman said in the worst-case scenario, the “fiscal cliff” facing the U.S. will shave almost 4 percentage points off gross domestic product (GDP) in the first half of 2013.
The fiscal cliff refers to the expiration of Bush-era tax cuts and the payroll tax holiday, as well as the end of extended unemployment benefits and the automatic spending and budget cuts mandated by Congress if lawmakers fails to reach deficit reduction goals.
According to Goldman, if the knock-on effects of a GDP contraction are considered, that is, reduced growth in one quarter weighs on the following quarter, the U.S. economy could experience a 5-percentage-point reduction in annualized quarter-on-quarter GDP.
First of all the Goldman report does not discuss what the US GDP would actually be (which is what this CNBC reporter is insinuating in the first sentence). Instead the report tries to quantify the impact of the fiscal cliff on the US economy. Second, this is Goldman’s “worst case” scenario, not the “base” case. In fact, Goldman ran 3 scenarios:
1. The “base” case assumes that
- Expiring 2001 and 2003 Bush era tax cuts will be extended again (this is probably the most controversial assumption).
- The “sequester” (which kicks in because the Supercommittee was unable to reach an agreement) required cuts in discretionary spending are delayed past 2013. It would likely be replaced with longer-term spending cuts.
- Unemployment benefits will be phased down gradually after the end of 2012, rather than expire on schedule.
- The payroll tax cut would in fact expire.
- Reductions in federal spending that are already in play will start taking effect.
2. Status quo: Everything gets extended (but the expected slowing in federal spending continues).
3. The “fiscal cliff”: All the tax breaks expire and spending cuts kick in as described here.
The chart below shows the impact of each of the three scenarios on the US GDP growth. It’s important to note that if the GDP growth is already negative (for example due to a spike in oil prices), the fiscal impact will make it even worse by the amounts shown in the chart (which is the point that CNBC seems to miss).
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| Source: GS (click to enlarge) |
20 Comments
The issue is getting more attention in the media, but I remained very concerned about what the politicians in Washington D.C. will do. I’m a registered Republican, lean heavily towards Libertarian on many issues, but because of what I’ve learned about MMT & MMR on this site (and Warren Molser’s site) I find myself wincing when I hear a politician talk about “becoming Greece”, balancing the budget, etc.
I know the “base case” is supposed to be the expected result…but, I also believe the “fiscal cliff” (or some permutation of it) has a higher degree of probability attached to it, than would normally be expected. Look at the political environment all these issues will have to be settled in:
#1) A lame duck congress (and possibly a lame duck president)
#2) U.S. budget ceiling will need to be extended (and its not impossible that the U.S. will consciously choose to default on it’s own debt !)
#3) Eurozone contagion could further complicate decision making
I expect plenty of political nonsense/payback, and idealogical intransigence…we live in interesting times ! (to say the least)
That seems far-fetched that taking $800 billion in tax cuts and spending out of circulation would cost the economy 4 pct of growth.
Remember that the $800 billion stimulus a few years ago had almost no impact on jobs or growth.
There is also the bizzaro world logic that if you raised the deficit by another $800 billion that you would get a 4 pct economic boost. Who believes that?
Many would make the case that the $800 billion did a lot to prevent a further downward fall and helped GDP and the stock market to start moving forward in 2009. Probably also helped keep unemployment from rising about 2% more, to say 12% instead of 10%. Just because it didn’t create 4% GDP growth doesn’t mean it didn’t have an impact.
The stimulus was far too small, but it still worked. Take money out of the economy, especially money that people actually spend (eg UE benefits) rather than save (eg tax cuts for the rich) and GDP will drop. When private sector debt is deflating, and the Gov doesn’t deficit spend (stimulate), look out below.
Johnny,
You must be new here. Go read some MMT basics
Hoops, I’ve read the basics.
In the case of the stimulus, it didn’t do what officials said it would do, so the story changed to: ‘Well, it prevented a worse recession.’
And no, I don’t believe that endless stimulus and deficit spending will lead to long-term growth.
I don’t think the politicians in DC will add (a lot of) water to the “”fiscal cliff”"-wine. Simply too many politicians face re-election. Especially, the sequestering will prove to be VERY unpopular.
I need to rewrite my comment.
I think the politicians in DC will add (a lot of) water to the “”fiscal cliff””-wine. Simply too many politicians face re-election. Especially, the sequestering will prove to be unpopular.
The big question becomes: WHEN (not IF) are the bond vigilantes going to show up in the US ? The bond vigilantes are the only ones that can “”beat the crap out of”" a politician.
still promoting the “bond vigilante” myth, even on pragcap, Mr Market??? Why even bother showing up here if you refuse to believe anything said here?
The next 6 months are difficult to predict. It is not business as usual. The US government is going to have to shore-up Europe. What happens next January, light years away………….
Shore up Europe? How in blazes could we do that? Only the ECB and the EU government organs can shore up Europe. They are the issuers of the Euro.
I think Europe is the least of our concerns. And if the value of the Euro does collapse vs the dollar, it will be very nice for holiday makers.
The Fed could buy Eurobonds.
the story is not tax cuts expiring, the story is mr dimon was in florida visiting chase branches when his derivative position blew up. when he trades derivatives he has a high salaried team, if it works the profits help his salary and some of the other big shots. the question that no one is asking is: Is derivative trading propping up chase being able to open branches, something that means they hire and also occupy commercial real estate both “trickle down to main street” things! and are derivatives also propping up free checking?! yes i am aware of how cheap it is for the banks to get money from the fed, and that is exactly why i as this! instead of talking about their latest trades and wondering about central bankers and pols let us ask right now if free checking, something as american as apple pie, occupancy of commercial real estate, and basic jobs in banking need to be supported by risky derivative trading!!! if that is the case and people are worried about debt than we should pay to have a checking account! if derivatives are simple being used to support new york city as it has evolved under michael bloomberg with its horrific brazil like gap between rich and poor, and that connected people from both parties have a manhattan apartment as a badge that shows they are “somebody” then it should be farmed out to hedge funds and other places where the tax payers are not on the hook. the ny metro area is not everyones problem! what is the average person getting from too big to fail banks making dangerous trades! someone who knows bank operations please lay it out!!!
“free checking” is highly profitable for banks. It comes with a slew of penalty fees much like low interest rate credit cards or teaser rates… the penalties for being late just once are enormous, and the people who need “free” checking are the ones most likely to trigger the penalties.
I suspect that the banks are broke and the Fed knows it, so the Fed is trying to drive up the value of their investments and facilitate trading gains.
The Fiscal Cliff is a concern, especially if we have divided government after the next election. If we have unified government, any expiration can simply be undone retroactively after January 20, and hardly anyone would notice. I think the worst case scenario is a continuation of the status quo in political control of the House, Senate, and Presidency.
One must also be concerned about a true black swan. I saw this article:
http://enenews.com/former-fukushima-daiichi-worker-i-believe-the-country-will-be-evacuated-if-the-no-4-spent-fuel-pool-collapses-should-be-hundreds-or-thousands-of-people-working-furiously-every-day
I don’t even half believe it, but the Japanese have already demonstrated incredible incompetence in their whole nuclear disaster after the earthquake. What if they allowed an uncontrolled criticality of the #4 waste fuel pool to actually happen?
Tidy GDP analysis shows that the situation is more dire now than it was the last time Congress punted on the issue, in 2009: http://peterosterlund.com/investing/stock-market-cliff-05-12/
Interesting that Goldman did not mention private debt in their analysis. That is like avoiding the elephant in the room. In the mid 1940′s, private debt to GDP ratio was only 40%. Today it is almost 300%. (WW2 paid down banker credit money with the fiat money spent from the government spigot.)
When people are in debt, that is “debt deflation.” Money is vectored out of the pocket of the citizenry and flows toward debt service. In a way, it is an unclaimed tax. The productive side of the economy is not stimulated as this usury money is diverted. Rising house prices in the bubble economy left a legacy of debt service that is continuing to suck wealth out of the productive side of the economy.
The FIRE sector will always try to do asset inflation, because a normal economy will not need to borrow that much, as existing money stock can be used to trade our output. Banks and insurance companies will attach real assets to their ledgers, and monetize them with debt issuance. This creates rising asset values and prices, with them riding the credit wave. In other words, when credit is used to bid up asset prices, then that is when we get into trouble. When an asset bubble crashes, assets can be confiscated by the creditor (banks) and the government is subordinated for bailouts. This makes the goverment the rump on a credit world.
The recipient of the debt service can respend it back into the economy, or they can hoard it (or use it to bribe politicians). In this case it would be debt merchants like Goldman Sachs who are recipients of our wealth transfer. No wonder there is not a word spoken of private debt in their analysis.
A potential way to fix debt deflation (BSR) is to Quantitative Ease the population. Everybody gets a “government money” check. Those who are in debt, have to spend it on paying down the ledger. Those who are not in debt, get to keep it and spend it. In this way, the savers are not punished, as they get as much as the debtors.
Of course, we will have to bypass the banks to do it, and that includes Goldman. In the end, with direct QE, the banker makes less future income on usury transfers as the loans are paid down.
Why do we listen when the vampire squid squeaks?
The two week lag between finding loans and finding reserves allows credit to expand beyond base money. This is why private credit to GDP ratios are so high, and credit such a large component of the economy. The FED is under tremendous pressure to accommodate already made loans, or the bank will have to recall, causing a collapse. Goldman and other private banking entities do not want us to examine the nature of credit money, hence Goldman avoids discussing what really matters.
See Alan R. Holmes, then VP of the NY Fed, in “Operational Constraints on the Stabilization of Money Supply Growth”:
The reserve creation process is lagged after the money creation process, in such a way that repayment of loans creates reserves before they are required for the settlement process.
Holmes summed up the Monetarist objective of controlling inflation by controlling the growth of Base Money— and by inference the Money Multiplier model itself—as suffering from “a naive assumption”:
The banking system only expands loans after the [Federal Reserve] System (or market factors) have put reserves in the banking system.
In the real world, banks extend credit, creating deposits in the process, and look for the reserves later. The question then becomes one of whether and how the Federal Reserve will accommodate the demand for reserves. In the very short run, the Federal Reserve has little or no choice about accommodating that demand; over time, its influence can obviously be felt. (Holmes 1969, p. 73; emphasis added)
“The reserves required to be maintained by the banking system are predetermined by the level of deposits existing two weeks earlier.” (Holmes 1969, p. 73)
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Causation thus runs from loans to deposits and loan repayment to reserves.