The buzz in the media is non-stop: Fiscal Cliff, fiscal cliff, fiscal cliff.
Unfortunately, a lot of people have no idea what it means, or why it’s significant. A lot of people think it has something to do with our huge deficit or national debt. In fact it’s just the opposite: The goal right now is avoiding deficit reduction, by preventing spending cuts and tax hikes that could be economically crippling.
To understand the significance of this event, a Richard Koo presentation from this spring given at the Institute For New Economic Thinking in Berlin is a great jumping off point to get a framework for thinking about this economy.
Koo, an economist at Nomura, is an expert on the great lost decades of Japan, and he’s broken new ground in understanding the unique nature of balance sheet recessions. A balance sheet recession is one that’s characterised by the private sector aggressively paying down debt. Monetary policy has very little effect in this type of a recession, and instead what’s required is aggressive fiscal stimulus, so that government debt counteracts the private sector debt reduction. In Japan’s downturn, it’s been the periods of premature fiscal tightening that have resulted in the most lost ground.
This presentation took a look at the state of the global economy, what’s been tried to jump start things, what’s worked, and what hasn’t. A few of the economic datapoints are a tad old now, but the themes are very relevant.
This is the most important chart: When Japan tried fiscal austerity, the economy deteriorated and the deficit got WORSE!
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