We all know what happens if the entire fiscal cliff takes effect for all of 2013: Some $720 billion gets taken out of the economy, growth craters and the United States runs a major risk of falling sharply into another recession. But what happens if we go over the fiscal cliff briefly — namely, if Democrats make good on their threat to go past Dec. 31 if Republicans don't agree to compromise on the Bush tax cuts?
Economists agree that it would take a little while for the fallout to take effect. But their prediction of the ultimate damage depends on how soon policymakers are able to come to a deal thereafter, and what it would look like. And on that, they have significant differences.
Mark Zandi, chief economist of Moody's Analytics, doesn't think there'd be much damage in the immediate days and weeks after the Dec. 31 deadline. "I don't think there is a substantial economic risk in going over the cliff briefly if it appears policymakers are moving towards a deal, particularly if it is a grand bargain," he said, pointing out that the Treasury Department could forestall tax withholding changes and government agencies could temporarily put off big budget cuts.
That said, Zandi acknowledges that the risks to both the financial markets and the broader economy would continue to grow "with each passing day there is no deal." And Congress would have to come to a deal within a few weeks to prevent real and possibly lasting damage, he explains: "If policymakers can come to terms by mid-January, I think there will be no meaningful impact on the economy, but if by early February there isn't a deal, the first quarter will likely be negative, and if there is no deal by mid-March, when the Treasury is no longer able to navigate around the debt ceiling, then the economy will descend back into recession."
Zandi's analysis is likely to be embraced by those who are advocating for Congress to go over the cliff — or at least be willing to do so — to force Republicans into accepting bigger tax increases. After Jan. 1, the argument goes, taxes would be reset to Clinton-era rates and Congress would be in a position to vote for lowering taxes.
But others are skeptical that Congress would be able to come together very quickly and resolve their differences very quickly. If we go over the cliff, "I'm not sure how you get anything done until after the inauguration," said Michael Hanson, chief U.S. economist for Bank of America Merrill Lynch Global Research, predicting that it would take until "late February or early March" to reach a resolution.
And by that point, significant damage would be done. "It's a messy process that could still damage the economy. It definitely increases the chance of having one quarter if not two of negative growth," Hanson said. "There would be a sharp sell-off in the equity market, in business and consumer confidence."
That said, Hanson doesn't expect the markets to start plummeting Jan. 2. If we go past the deadline, "Markets will probably be saying, 'They played that branch of the game, it's no big deal,' " he explained. "Probably it would take the first, maybe the second failed vote. That's when in some sense all hell breaks loose."