A recent report from the Carlyle Group, “There Are Worse Fates than Walking off the Fiscal Cliff,” reaches very similar conclusions to our recent report, “Misguided ‘Fiscal Cliff’ Fears Pose Challenges to Productive Budget Negotiations.”
The tax and spending changes required under current law are often referred to as the “fiscal cliff” because of how sharply they would reduce the budget deficit. Both we and the Carlyle group conclude that, sadly, letting these policies briefly go into effect in January may be our best hope for breaking the current budget gridlock and negotiating the kind of deal most experts believe we need to both support the economy in the short term and promote fiscal stability in the intermediate-to-longer term. We each conclude that simply extending current policies would be a serious mistake.
Our analysis suggests that if current law initially takes effect, the economy will not immediately fall off a cliff and plunge into a deep recession in early January. Rather, the economy will start down a slope that would likely be relatively modest at first (and then much steeper if 2013 unfolds without a fiscal resolution). This means that if there is no agreement by January 1, policymakers will still have some (although limited) time to take steps to avoid the serious adverse economic consequences that the Congressional Budget Office (CBO) outlines in its recent analysis of what will happen if the expiring tax cuts and new spending cuts take effect on a permanent basis.
We think this resetting of the budget could be what is needed to get policymakers off the dime and negotiating seriously. The Carlyle Group report reaches a similar conclusion:
Virtually every macroeconomic analyst’s preferred outcome would be a “Grand Bargain” that replaces the fiscal cliff with a credible alternative that phases-in the deficit reduction over a period of years.
…Should a negotiated settlement on long-run deficit reduction fail to materialize during the lame duck session, the most likely alternative might be a simple extension of current fiscal policy. While such an outcome would improve the near-term economic growth prospects, it would also relieve the pressure to agree to credible deficit reduction and substantially worsen the longer-run outlook. The best outcome, therefore, might be the expiration of current fiscal policies to create real pressure for both parties to work together and quickly reach a “Grand Bargain.”
The Carlyle analysts are realistic, however, and recognize that the success of such a policy depends critically on lawmakers convincing market participants that their plan is indeed credible. (Here are our principles for making deficit-reduction efforts credible — that is, more likely to be effective and sustainable over time.)
Our reports end on a remarkably similar note. Carlyle says
While the fiscal cliff would be a near-term disaster, an extension of 2012 fiscal policy that fails to address increasing indebtedness could actually represent the worst long-run outcome.
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.