Last-Minute Fiscal Cliff Deal Falls Short From Three Economic Theory Perspectives; Keynesian Theory, Spending/Debt Theory, And Uncertainty

Wednesday, January 02, 2013 08:21
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Last-Minute Fiscal Cliff Deal Falls Short From Three Economic Theory Perspectives; Keynesian Theory, Spending/Debt Theory, And Uncertainty

Tags: Congress | deficit | Economic Outlook

Economists say the new deal to avoid the fiscal cliff falls short under three basic economic theories:
  • The Keynesian theory that pushes for more government spending and lower taxes
  • The spending/debt theory that pushes for exactly the opposite
  • The uncertainty theory that can keep businesses from investing and markets from rallying
The compromise reached by the Senate and House in late-date negotiations will not bolster consumer spending, will not rein in government spending, and will increase the national debt by trillions of dollars.

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If a deal had not been reached, trillions of dollars in debt would have automatically been trimmed.
And it only eliminates part of the uncertainty that has been keeping business investment on hold.
 
The deal prevents the most critical components that, if a deal had not been reached, were feared to adversely affect the still fledgling economic recovery.
 
The White House made a statement that the deal will bolster economic growth. External economists disagree, primarily because they are focused on things like the 2% payroll tax increase that they say will completely counter the extension of middle class tax breaks.
 
This will keep consumer spending muted. The deal does give a clear answer about what marginal tax rates will be for investors and business executives.
 
But it also sets up significant policy showdowns over the next several months, one of the first of which will be the federal debt ceiling.
 
The failure to address the sequester—the spending cuts that automatically came into play—along with the uncertainty about the debt ceiling could become a significant drag on the markets.
 
As is, the markets look like they may celebrate the fact that some sort of deal was reached and that some major concerns like the farm bill and the AMT tax were addressed.
 
Failure to fix the farm bill could have resulted in an introduction to inflation through a spike in prices for dairy products.
 
Failure to address the AMT tax would have resulted in significant tax hikes that would have blindsided middle class taxpayers.
 
The low-hanging fruit of the fiscal cliff negotiations was picked. The markets’ next worries may be by what means—or even if—Congress will be able to reach the top of the tree.

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