Recession imminent if ‘fiscal cliff’ of tax hikes, budget cuts not averted, CBO says

The U.S. economy will hurtle into a recession if Congress fails to avert a series of tax increases and budget cuts due in January, the Congressional Budget Office said Wednesday, warning that a fiscal impasse would have consequences even more dire than previously forecast.

The CBO’s gloom sparked another round of political finger-pointing but failed to cast much of a shadow over financial markets. That’s because the Federal Reserve is inclined to act “fairly soon” to boost the slow pace of economic recovery, according to minutes the central bank released Wednesday. Moreover, new data showed signs of modest improvement in the housing market.

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Falling off the 'fiscal cliff' into recession?

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All of which raises a quandary for some economists: If Congress is about to steer the nation over what is being widely dubbed a “fiscal cliff” by failing to agree on a budget, then maybe the Fed should save its ammunition. Let things get really bad, then act.

“Why do you want to waste your ammo now if you’re going to go off a fiscal cliff at the beginning of next year?” said Edward Yar­deni, president of Yardeni Research, urging restraint by the Fed. By revving up the economy before it reaches the cliff, Yardeni said, “maybe [the Fed] thinks we can do an Evel Knievel and jump right over it. But I don’t get the logic of that.”

But the Fed minutes indicated that most of the members of its Open Market Committee think otherwise.

“Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery,” said the minutes of the meeting, held July 31 and Aug. 1.

The Fed debated a variety of tools for boosting growth, including extending its commitment to ultra-low federal funds rates past 2014, linking those rates to economic indicators, launching a new round of purchases of Treasury and mortgage securities, and initiating a plan to encourage bank lending.

With just 2¹ / ₂ months left until the presidential election, it may be too late for monetary or fiscal policy to significantly alter the state of the economy before voters head to the polls. But actions taken now by the Fed or Congress might still influence whether voters believe the economy is on the right track.

A steep cliff might not look like the right direction, though, and the CBO said businesses might delay hiring or investment if the outlook is threatening.

In its report Wednesday, the CBO warned that the nation would be plunged into a significant recession during the first half of next year if Congress fails to avert nearly $500 billion in tax increases and spending cuts set to hit in January.

The massive round of New Year’s belt-tightening — known as the “fiscal cliff” or “Taxmageddon” — would disrupt recent economic progress, push the unemployment rate back up to 9.1 percent by the end of 2013 and produce economic conditions “that will probably be considered a recession,” the nonpartisan CBO said.

The CBO’s economic outlook is considerably darker than the forecast the agency released in January, when it predicted that the fiscal cliff would trigger a mild recession in the first half of 2013, with the economy shrinking by 1.3 percent. Now the agency foresees a contraction of 2.9 percent in gross domestic product, “similar in magnitude to the recession of the early 1990s.”