Fiscal Cliff MEGATHREAD: Wile E. Economy falls off, lands in cloud at bottom

[derspiess]

He's not flying there specifically to give the speech to fuck over Yi's and your rich friends.  His comments will be an aside to the main reason for the visit.  And why shouldn't he, anyway?  The public is part of the debate;  the GOP is seeing to that.

There's nothing wrong with him trying to whip up support for his policies.  There is something wrong with suggesting that his trip to Michigan wasn't for that purpose but came about simply because Daimler invited him--it's disingenuous.

Not disingenuous;  merely a coincidence.

[DGuller]

As a nation we would be consuming 95% of what we were the day before.  That can very much be not so bad.

The problem is that we're not going to be 95% as productive as before, so unemployment will go up, so will the related chain events.  It is a bit bothersome that our economy is almost always defined in how it changes, and not where it is, but that's what people perceive.

[Sheilbh]

Which one is the 5% the cutting spending or the raising taxes? 

That's the combined total.  Even the stuff that's most likely to occur totals 1.9% of GDP.  That's a big chunk - in one year - for a weak economy to take.

We already did the almost default thing.  That's water under the bridge at this point.  If are going to be frightened over that, then they are already frightened.

And the effect was the biggest fall in the stock market since 2009, the GAO estimates the cost to the US government of that fight was $1.5 billion and long-term to the economy was $19 billion.  It's an expensive bit of political grandstanding.

As a nation we would be consuming 95% of what we were the day before.  That can very much be not so bad.

Except it's already having an effect.  61% of companies have said the fiscal cliff uncertainty is affecting their hiring plans and durable goods orders are stagnating this year because they don't know how much disposable income their consumers will have.  If you combine that size of tax increases and spending cuts with ongoing private sector deleveraging, in a context of weak global demand then the fiscal multiplier effect could be even larger than the latest IMF estimates.  The Economist a while back quoted a couple of CEOs of global  firms saying they'd expect a worldwide recession - which last happened in 2008-9 and before that hadn't happened since the recession.  It would be a disgrace because it was so easily avoidable.

I can't believe you're actually making the argument that the US government's credibility is at stake.

One of the jobs of a government - one of the most important - is to provide a stable, secure and predictable environment for economic growth.  Without it companies and individuals aren't able to plan.  The problem with the debt ceiling wasn't that the US would default - I don't think anyone believed that even at the worst points - but that the system had become so dysfunctional that default was even a possibility.  As the CFR put it on the debt ceiling a shutdown's bad for individuals but it's nothing to the symbolic message of political failure that the debt ceiling debacle sent to the markets (which would've been worse without the deal).  I think it's similar here, everything I've read about the markets and the fiscal cliff says that they expect a deal.  If it fails then I think it's another slide to a situation where American businesses and investors have to be wary of and take steps against political risk.  According to the National Federation of Independent Businesses 35% of respondents said that uncertainty over government actions was a critical concern and it was the fourth biggest problem for small businesses (behind healthcare costs, uncertainty over economic conditions - which is linked - and fuel costs).

I don't see how you can judge Washington as a rational actor any more if both parties can't agree to avoid an average household tax increase of $3 500 and indiscriminate spending cuts in a weak economy when it's in both of their interests to avoid it.  If economic policy is no longer stable and predictable by the markets then that will have a significant effect on investment.

[CountDeMoney]

Pfft, what do you guys in England know about radical and rapid austerity, anyway?   

[Sheilbh]

I think you can credibly argue the UK's austerity of about 1% a year is about right, though I'd disagree.  Arguing that 5% this year - which is literally only comparable with Greece - wouldn't be so bad is madness. In addition British austerity has been clearly signposted throughout, it's predictable which is a virtue.

The delusion, especially among Democrats, that it'll be okay if they step over the fiscal cliff seems dangerous.  The view they can just take one step over and then it'll be okay because they'll be able to fix it shortly afterwards, because Republicans will be voting for a tax cut not tax rises, strikes me as too political by half.  Again it goes to credibility, there is a problem with a government that cuts spending and raises taxes as part of political sleight of hand.

[CountDeMoney]

Meh, doesn't matter anyway.  GOP won't make a deal anyway;  if they can't beat Obama in an election, destroying his second term is the next best thing.  Prezzidizzle will be the one holding the bag, and that's OK by them.

[The Minsky Moment]

Yes it would. You can't cut spending and increase taxes, overnight, by 5% of GDP and it 'not be so bad'.

As a nation we would be consuming 95% of what we were the day before.  That can very much be not so bad.

How?
Let's go back to the accounting identity: Y(GDP)=C+I+G+(X-M)

The proposal is to cut C+G by 5 percent.
The austerity may reduce imports so X-M may improve.  But C+G is on the order of $14 trillion, whereas imports and exports are in the 2-3 trillion range, so there would have to be massive trade effects to offset the spending drop.

Which means the only thing that would prevent a massive recession would be a huge increase in private investment.  So one would have to assume that businesses will suddenly start investing madly out of euphoria over the prospect of a balanced budget in 2020, notwithstanding the fact that their domestic market has shrunk overnight by 5 percent.

I am not convinced.

Note that I haven't even taken into account the possbility of negative multipliers over 1, as per the recent IMF study.

[Syt]

Y(GDP)=C+I+G+(X-M)

Dear lord, I was just taken on a flashback into 1992 to my first macroeconomics class at school.

[Admiral Yi]

What you seem to be suggesting Joan, is that we can only reduce the deficit to the extent that it does not drive GDP growth into the red.  That seems to me to result in a pretty long time frame before we're back on a sustainable path.

[The Minsky Moment]

What you seem to be suggesting Joan, is that we can only reduce the deficit to the extent that it does not drive GDP growth into the red.  That seems to me to result in a pretty long time frame before we're back on a sustainable path.

Not necessarily.  If the economy recovers to something nearer to full employment and credit growth recover, then fiscal multipliers could dip below one, and it could be possible to have net fiscal consolidation without negative GDP growth.

the alternative of tanking the economy leads to a catch the falling knife problem, because then you are just applying higher tax rates to a falling income base.

[Admiral Yi]

If the fiscal multiplier dips to 1, then we can cut 2% of our 8% deficit and reduce GDP growth to zero.  That still leaves us a way to go.

If you wouldn't mind, please explain to me the linkage between unemployment, credit growth, and the fiscal multiplier.

[The Minsky Moment]

If you wouldn't mind, please explain to me the linkage between unemployment, credit growth, and the fiscal multiplier.

Under conditions of full employment, deficit financing isn't going boost growth (resources are already fully employed) so there is no multiplier.  There may be a risk that cutting spending may knock the economy off the full employment path, but if economic conditions are good, then private credit growth (i.e. private deficit financing) can offset the loss of public deficit financing.

[Admiral Yi]

It seems now that you are proposing an even more impossible standard for deficit reduction than I had originally thought.

We can only reduce the deficit in conditions of full employment, when the deficit is having no positive effect on output and growth.  I.e. when the multiplier is zero.

[derspiess]

It seems now that you are proposing an even more impossible standard for deficit reduction than I had originally thought.

We can only reduce the deficit in conditions of full employment, when the deficit is having no positive effect on output and growth.  I.e. when the multiplier is zero.

Yeah.  And from what I'm hearing we need to do another stimulus (creating an even more insurmountable debt) to get to that point!

[The Minsky Moment]

It seems now that you are proposing an even more impossible standard for deficit reduction than I had originally thought.

We can only reduce the deficit in conditions of full employment, when the deficit is having no positive effect on output and growth.  I.e. when the multiplier is zero.

No I did not propose that.
Reread post 39.