Read of the Day: “What if we go Off the Cliff Just a Little bit?”

The fiscal cliff debate is becoming increasingly contentious as politics come to the forefront.  On the one side, Democrats are increasingly in favor of going over the cliff because that might swing the negotiating leverage in their favor once the Bush tax cuts expire and provide Democrats with the argument to encourage new passage of tax cuts for the middle class (thereby maintaining upper class increases).  Republicans want a deal done quickly so the Bush tax cuts remain mostly in place and aren’t able to expire at year-end.   Of course, the Democrats might be sending us over the cliff if things work out as some desire.  So then the real question is, “what will happen if we go off the cliff just a little bit”?   Neil Irwin of the Washington Post’s Wonkblog has some good thoughts on this:

But that isn’t really the most urgent economic question to ask; no one in government is advocating for all that austerity to take effect permanently. The fundamental question for next year is: “What will happen if we go off the cliff just a little bit.” If we have one, or two, or four weeks of automated austerity, would it really matter?

Some would argue that it won’t be very bad at all. That’s the answer the normal analytical tools would offer. But this is one of those situations where the normal analytical tools might be leading people astray: There is every reason to think even a short exercise in cliff-diving would hurt quite a lot.

“I fear it could be much, much worse than those who blithely assert that it wouldn’t be so bad,” said Michael Feroli, chief U.S. economist at J.P. Morgan Chase.

This also is one of the most important questions hanging over the negotiations, because it is a much more likely scenario than going off the cliff entirely and permanently. It’s also a situation we can’t know for sure, simply because the situation is unprecedented.

In a narrow sense, a short voyage off the cliff shouldn’t crush the economy too badly. The CBO estimates that the full brunt of the policies add up to about $56 billion a month, which is a lot of money — about 4 percent of GDP — but should, in theory at least, do only modest damage to the economy if it lasted only a few weeks. One month of austerity along those lines would subtract only about a third of a percentage point from growth for the full year, before accounting for multiplier effects.

For comparison, the U.S. economy grew at a 1.8 percent rate over the last year; if a single month of fiscal cliff-style austerity had been in place, that number would have been more like 1.4 percent. For a middle income family, based on numbers from the Tax Policy Center, a single month over the cliff would cost $167 — and even that may be completely or partially refunded if Congress makes an eventual deal retroactive, which there is a good chance it would.

Read the full article here.

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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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