If there are no changes to current law, 2013 promises to bring a big wave of fiscal tightening.
This is due to the fact that spending cuts are kicking in at the same time that the Bush tax cuts are due to expire.
According to a chart from Nomura, it’s theoretically possible that fiscal contraction could knock 5% off of GDP.
But at least then we’ll be cutting the debt, right?
A chart in Richard Koo’s latest monster presentation shows what happened in Japan when they tried fiscal consolidation during their long balance sheet recession.
Both times the economy got dramatically worse, and the deficit EXPANDED. Not only did things get bad, but the theoretical benefit didn’t happen either.
Figuring out a way to defuse the 2013 fiscal bomb is critical.