Here's what I said about Winston Churchill and the fiscal cliff in a just-published op-ed in the Financial Times.
Rights and wrongs of the US fiscal cliff
By Stan Collender
Winston Churchill’s oft-quoted observation about America – always doing the right thing but only after it exhausts all the other options – is being tested as it deals with what US Federal Reserve chairman Ben Bernanke in February labelled the “fiscal cliff”. Mr Bernanke coined that phrase to warn policy makers about the $600bn or so of tax increases and spending cuts that will go into effect on January 1 and 2 unless the US Congress and President Barack Obama enact legislation to stop them from happening. He was right to worry. The Congressional Budget Office and a number of Wall Street companies are projecting that in 2013 the US economy will fall back into recession and unemployment will rise above 9 per cent if we go over the cliff.
The “right thing” should not be hard to figure out. Certainly, the “wrong thing” is clear enough. The fiscal cliff would be the worst fiscal policy implemented in the US since the end of the Depression, when lawmakers put an austerity programme in place before the economy was ready and pushed the country back into recession. Rather than arguing about it, politicians should be rushing to take credit for preventing it from happening.
However, there are two reasons why the right thing isn’t as obvious as one might expect.
First, politics is as much a part of the fiscal cliff debate as economics. The election left the two major political parties more ideologically apart than they were before. The two sides are still figuring out what is right for them – rather than for the country – as they manoeuvre in a hyper-partisan environment few see ending any time soon.
Second, even if the politics were clearer, the optimum economic solution is not obvious. After the debt ceiling debacle of August 2011, the three leading credit rating agencies indicated that the success of the political system in dealing with the fiscal problems would be one of the major factors in determining whether the US was downgraded.
But it is worth asking whether, at least in the eyes of the rating agencies, going over the fiscal cliff would be a sign that Washington was solving America’s debt problems.
The tax increases and spending cuts would reduce the US debt-to-gross domestic product ratio, a favourite metric of the rating agencies. They could be seen as a political success because for a change policy makers would not have blinked when presented with an opportunity to increase taxes and cut spending.
So once again the US is left with a set of better and worse options, rather than a clear case of right and wrong. In the short run, the cliff should be avoided. A new recession when the US is still recovering from the last one, and when there are slowdowns in the eurozone and Asia, is too much to risk, no matter if the deficit is reduced. What matters is that any deal does not abandon the prospect of deficit reduction and decreased borrowing in the course of Mr Obama’s second term.
What, then, should a deal look like? First, the tax increases and spending cuts that are part of the fiscal cliff should be cancelled as soon as possible. In their place, a new plan needs to be considered that reduces the deficit and stabilises the debt when the US economy is better able to offset the impact of less government spending and higher taxation on both households and businesses.
Of course, such a delay carries large risks, given that political promises to do something later are typically less credible than actually reducing the deficit now. And, given that the promise to reduce the deficit in the future would be made after the fiscal cliff deficit reductions had been cancelled, a new promise might not be taken very seriously. That makes the strength of the agreement – including the kind of bipartisan support that has been so elusive in the US in the past few years – critical to making this work.
Which brings us back to Churchill. American policy makers once again may prove him insightful and do the right thing when it comes to the fiscal cliff. But the process of getting there is just as likely to prove him correct about how long it is going to take for whatever is “right” to emerge from the debate.
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