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The Insiders
Posted at 11:25 AM ET, 12/03/2012

The ‘fiscal cliff’ and playing chicken

The “fiscal cliff” has been compared to a game of chicken, but a recent article for the Toronto Globe and Mail points out the limitations of that analysis. (The article, written by Andrew Steele, is a very interesting tale on the fiscal cliff and informs much of my post today). 

According to game theory, a game of chicken assumes that both sides have consequences that are perfectly mirrored. In the famous James Dean scene in “Rebel Without a Cause,” where two cars speed toward one another, each side faces the same choice: injury (crash) or shame (backing down, by turning the wheel). But do both sides calculate their risks equally?

Risk assessment is the key variable in these negotiations. In the short term, as many have already pointed out, the risk assessment of both sides may lead them over the cliff — at least for a while. Republicans, despite some recent signs of compromising on taxes, have a lot to lose if they do so. What else does the Republican Party stand for, if not for no new taxes? What would happen to their brand if they caved on this fundamental principle?

Most Republicans still seem to sense the peril in backing down on their anti-tax pledge. As Peter Wallsten points out this morning in The Post, Grover Norquist is still very much alive and calling the antitax shots within the Republican Party. 

Similarly, President Obama may have decided that moving off his safe island of calling for the avoidance of automatic Jan. 1 tax increases on the middle class runs the risk of weakening his power, just replenished from his resounding reelection. So while, in the short term, both sides may calculate their risks differently, both sides may see more risk in compromise than in intransigence.

So how does the game change once we are over the cliff? Here, a new risk will become manifest: a new economic recession accompanied by a plunging Dow Jones index. With this new set of facts, the negotiations may qualify as a true game of chicken where both sides will face the same choice: make a deal or drive the economy into the ground.

In this theory, the fear of being blamed for a bad economy trumps previous assessments of risk. That scenario, of course, is knowable today, but without the  headlights of an economic calamity barreling down on the president and the Congress, a deal is less likely in 2012 than in 2013.

By  |  11:25 AM ET, 12/03/2012

 
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