Most of the discussion has focused on the domestic repercussions of going off the fiscal cliff (or as my former colleague Chad Stone calls it, the “fiscal slope”). I think it important to remember that, as the single largest economy, policy in the US has profound implications for economic developments overseas. This is particularly true with the eurozone still in a fragile state, and China growing (relatively) slowly.
Jim’s post yesterday tabulated the numerical components of the fiscal cliff. Goldman Sachs has used its own tabulation to estimate the impact on GDP growth over 2013 (SAAR), shown in Figure 1.
Figure 1: Effect on real GDP. Source: Goldman Sachs, “US Daily : The Composition of the Fiscal Cliff (Alec Phillips),” October 19, 2012 [not online].
Note that one difference between the BofA and GS calculations involves the size of the Bush tax cuts. BofA indicates $180 bn, while GS indicates $192. The consequential piece of information is that $56 billion of the $192 bn is associated with high income tax cuts. Retaining the lower tax cuts for incomes less the $250K means the fiscal cliff would be reduced by $136 bn.Nonetheless, with interest rates at zero, contractionary fiscal policy is likely to have large (negative) effects. (Obviously, I am ruling out “expansionary fiscal contraction”; strangely, I do not hear much discussion of this outcome being likely, this time around — where is the Republican JECwhen you need cheering up?).
The IMF, using slightly different numbers, concludes:
The fiscal contraction built into the fiscal cliff is 4 per cent of GDP (3 per cent of GDP more than in the WEO baseline). A range of models is used to consider the short-term impact of the fiscal cliff, from simple calculations with tax and expenditure multipliers to fuller scenarios using various modelling approaches, each of which has its own assumptions regarding the permanence of the cliff and associated confidence effects (Fig. 14). The largest—not necessarily the most likely—hit to US growth comes from the G-35 model because it treats the cliff as temporary (i.e., private consumption does not rise to offset lower public demand), and since it builds in negative confidence effects (i.e., a 15 per cent drop in stock prices, partially offset by lower long bond yields on account of the lower debt path). The spillovers from this model are also larger, and operate mainly via trade channels, which is why neighbours are most affected (Fig. 15). But China and several advanced countries would also suffer up to one quarter of the hit taken by US growth. Lower commodity prices—6–12 per cent for energy and 3–6 per cent for non-energy, depending on confidence effects and policy responses—also adversely affects net exporters of these goods. Were the assumed confidence effects more negative, so would be the spillovers. (page 10)
Exhibit 14 from the paper tabulates the various estimated impacts and assumptions.
Exhibit 14 from IMF (2012).The estimated impacts are relative to WEO baseline (which includes a 1 ppt of GDP contraction), so they pertain to a 3 ppts of GDP contraction. Multipliers pertains to application of multipliers as in most of the calculations, e.g., GS. GIMF, GPM and G35 are Global Integrated Monetary and Fiscal model , Global Projection Model  and a panel unobserved components model of 35 economies (Vitek 2012) .
Exhibit 15 from IMF (2012).The (relative) impact on economies around the world is illustrated in Exhibit 15.
Clearly, the impact is (relatively) largest for our neighbours, Canada and Mexico. But the impact on some other economies in a precarious state –- the UK, Germany, China, and Japan –- is also noticeable.
I would further note that expansionary monetary policy — such as implemented recently by the Fed in QE3 — cannot offset completely the contractionary impact of contractionary fiscal policy. In addition to the zero interest rate constraint, looser Fed policy tends to re-allocate economic activity toward the US.
Hence, the stakes for a successful resolution of the fiscal cliff are high, not just for the US, but for the world economy.
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