In a News Item of 1 October, Over the Cliff, we looked at the passing of the deadline that same day for Congress to agree a budget. We also looked at the looming deadline for Congress to agree a new higher ceiling for Federal Government debt, currently standing at $16.699 trillion. Without an agreement to raise the limit, the government will start becoming unable to pay some of its bills from around 17 October.
One week on and no agreement has been reached on either a budget or a higher debt ceiling.
Failure to agree on a budget has led to the ‘shut-down’ of government. Only essential services are being maintained; the rest are no longer functioning and workers have been sent home on ‘unpaid leave’. This has led to considerable hardship for many in the USA. It has had little effect, however, on the rest of the world, except for tourists to the USA being unable to visit various national parks and monuments.
Failure to raise the debt ceiling, however, could have profound consequences for the rest of the world. It could have large and adverse effects of global growth, global trade, global investment and global financial markets. The articles below explore some of these consequences.
U.S. Congress enters crucial week in budget, debt limit battles Reuters, Richard Cowan (7/10/13)
Debt ceiling: Understanding what’s at stake CBS Moneywatch, Alain Sherter (7/10/13)
Q&A: What is the US debt ceiling? BBC News, Ben Morris (3/10/13)
Five Reasons to Fear the Debt Ceiling Bloomberg (6/10/13)
A U.S. Default Seen as Catastrophe Dwarfing Lehma Bloomberg Businessweek, Yalman Onaran (6/10/13)
China tells US to avoid debt crisis for sake of global economy BBC News (7/10/13)
US shutdown is starting to hit business, says Commerce Secretary BBC News (6/10/13)
Why Australia should fear a US government default The Guardian, Greg Jericho (7/10/13)
Could the US default over just $6bn? BBC News, Linda Yueh (11/10/13)
IMF piles pressure on US to reconcile differences and prevent debt default The Guardian, Larry Elliott and Jill Treanor (10/10/13)
Republicans offer to raise US debt ceiling for six weeks The Telegraph, Peter Foster and Raf Sanchez (11/10/13)
- If a debt ceiling is reached, what does this imply for the budget deficit?
- How serious are the two current fiscal cliffs?
- How would a continuation of the partial government shut-down impact on the US private sector?
- What multiplier effects on the rest of the world are likely to arise from a cut in US government expenditure or a rise in taxes? What determines the size of these multiplier effects?
- Explain the likely effect of the current crisis on the exchange rate of the dollar into other currencies.
- Why might the looming problem of reaching the debt ceiling drive up long-term interest rates in the USA and beyond?
At the start of 2013, the USA faces a ‘fiscal cliff’. By this is meant that, without agreement by Congress on new fiscal measures, the USA will be forced into tax rises and expenditure cuts of around $650 billion (over 4% of GDP). This would probably push the economy straight back into recession. This in turn would have a serious dampening effect on the global economy.
But why would fiscal policy be automatically tightened? The first reason is that tax cuts given under the George W. Bush administration during 2001–3 (largely to the rich) are due to expire. Also a temporary cut in payroll taxes and an increase in tax credits given by President Obama are also due to end. These tax increases would form the bulk of the tightening. The average US household would pay an extra $3500 in taxes, reducing after-tax income by around 6%.
The second reason is that various government expenditure programmes are scheduled to be reduced. These reductions in expenditure amount to around $110 billion.
It is likely, however, that Congress will agree to delay or limit the tax increases or expenditure cuts; politicians on both sides want to avoid sending the economy back into recession. But what the agreement will be is not at all clear at this stage.
Republicans are taking a tougher line than Democrats on cutting the budget deficit; they are calling for considerably less restraint in implementing the government expenditure cuts. On the other hand, they are likely to be less willing to raise taxes.
But unless something is done, the consequences for 2013 could be dire. The fiscal cliff edge rapidly approaches.
Nearly 90 percent of Americans would see taxes rise if ‘fiscal cliff’ hits Washington Post, Lori Montgomery (1/10/12)
Fiscal cliff a serious threat, but unlikely CNN Money, Chris Isidore (1/10/12)
“Fiscal cliff” fears may impede faster job growth Chicago Tribute, Lucia Mutikani (1/10/12)
Avert Fiscal Cliff With Entitlement Cuts, Tax Increases Bloomberg (2/10/12)
‘Fiscal cliff’ to hit 90% of US families Financial Times, James Politi (1/10/12)
Investors don’t want the US to fall off the fiscal cliff The Telegraph, Tom Stevenson (22/9/12)
Gauging the fiscal cliff BBC News, Stephanie Flanders (27/9/12)
The US fiscal cliff – and the fiscal chasm BBC News, Stephanie Flanders (2/10/12)
US fiscal cliff threat fails to galvanise policymakers Guardian Economics blog, Mohamed el-Erian (1/10/12)
Multiplying Europe’s fiscal suicide (technical) The Telegraph, Ambrose Evans-Pritchard (1/10/12)
Q&A: The US fiscal cliff BBC News (7/11/12)
US election: Four more years… of what? BBC News, Stephanie Flanders (7/11/12)
United States fiscal cliff Wikipedia
- Explain what is meant by the ‘fiscal cliff’ and what is its magnitude.
- What would be the multiplier implications of the USA ‘falling off the cliff’ both for the USA and for the rest of the world?
- What factors determine the size of the government expenditure and tax multipliers? What would be the problems of (a) underestimating and (b) overestimating the size of these multipliers?
- How can a fiscal stimulus be reconciled with a policy of reducing the size of the budget deficit as a proportion of GDP over the longer term?
- In what ways can the actions of Democrats and Republicans be seen as game playing? What are the possible payoffs and risks to both sides?
- Is relying on export growth to bring the world economy out of recession a zero sum game?
- Explain which is likely to be more effective in stimulating short- and medium-term economic growth in the USA: fiscal policy or monetary policy.