Get used to more fiscal cliffs

January 2, 2013

There is a fiscal cliff deal, and it will become law. That is the good news. Our long national nightmare of 34 hours having fallen off the fiscal cliff (and counting, until the president signs the legislation) is over.

But most important thing to know about the deal is this: This resolves nothing.

Markets, which remained remarkably calm throughout the negotiations (Wall Street has learned a thing or two about seeing through Wall Street brinksmanship), rallied Wednesday morning on having one big weight removed from the outlook. American households making less than $450,000 will see no 2013 tax increase (except for the end of a two percentage point payroll tax holiday that everyone seems to forget, and which will cause a typical worker’s after-tax pay to fall by $1,000 this year).


Our debate over longer-term U.S. fiscal policy has only just begun. House Speaker John Boehner. (AFP/Getty)

In short, though, there will probably be no fiscal cliff-induced recession, though the end of the payroll tax break, no major stimulus designed to offset it, and tax increases on upper-income families will create a moderate drag on growth in 2013.

The U.S. stock market opened strongly Wednesday morning, with the Standard & Poor’s starting 2013 on 2 percent gain as of 10:30 a.m. and European stock markets up a bit more than that Wednesday. An index of expected stock market volatility, the Vix, plummeted.

Contrary to warnings from corporate America that the failure to reach a fiscal cliff deal that included major longer-term deficit reduction could cause a flight of capital away from the United States, the bond market was calm Wednesday. There also, it might be noted, was no apparent panic in the bond markets that the deal does not contain any major longer-term deficit reduction: The yield on 10 year Treasury bonds did rise 0.08 percentage points, to 1.84 percent, but bonds of other safe-haven nations like Canada, Britain, and Germany, rose even more. The dollar was stable against other leading currencies.

But the apparent victory comes with many clouds. As my colleagues Zachary Goldfarb and Jim Tankersley have argued, the deal doesn’t solve any of the major issues haunting the economy: In the short run, it offers no large-scale stimulus to try to get the economy back to full employment. It offers no longer-run strategy to reduce the budget deficit to sustainable levels. And it leaves a situation in which policy uncertainty will hang over the economy, starting with the next fight, over raising the debt ceiling in about two months. (Twitter wags are already trying to dream up the mildly clever sobriquet for the next debt stand-off. I’m partial to the “St. Valentine’s Day Massacre,”  but it looks as if the timing might make “March Madness” a better fit.)

After all the hype around the fiscal cliff, the resolution has contained nothing even close to a “grand bargain”. In hindsight, it was naïve to expect that the talks would generate a new framework for overarching tax reform and changes to entitlement programs that would create a more efficient U.S. economy in the longer-run, perhaps paired with steps to offset some of the pain of adjustment in the short run.

It was unrealistic because that’s how the American political system does policy. Iteratively, gradually, haltingly. A grand bargain would be the equivalent of the 1983 Social Security reforms, 1986 tax reform, and the 1990 deficit-reduction deal, all in one. But notice something important: Those things happened over a seven year period, not a six week period.

In other words, we should get used to this. There are fundamental changes that will happen to U.S. fiscal policy in the years ahead, both in tax policy, entitlements, and overall deficit reduction. But they will come about through a series of jaw-clenching negotiations that drive reporters and polticians alike batty. In a political system with so many distinct nodes of power, and with such complicated issues at stake, there is no other way.

All this doesn’t necessarily consign the economy to years more of stagnation. There was plenty of brinksmanship, and even a couple of government shutdowns, in the 1990s, which was quite a good decade for the U.S. economy. If the fundamentals are strong, the hijinks of Washington policymakers don’t matter much.

So brace yourself for a series of artificial deadlines and last-ditch negotiations and brinksmanship. And hope that the policies that come out of all that, several years down the road, involve both more sustainable public finances and a more competitive U.S. economy. Nobody ever said legislating was pretty.

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