SocGen: The Federal Reserve Is Underestimating The Impact Of The Fiscal Cliff

mountain goat, fiscal cliff

Photo: a.dombrowski via Flickr

The fiscal cliff is fast approaching and if Congress fails to act, more than $600 billion in tax and spending provisions are set to change at the end of the year.The Congressional Budget Office (CBO) recently revised its projections and now sees 2013 growth of 0.5 per cent in the presence of the fiscal cliff. The CBO anticipates a 1.3 per cent contraction in the first half of the year, and a “shallow recovery” in the second half.

But the Federal Reserve’s central growth scenario projects 2.7 per cent to 3.1 per cent growth next year. Societe Generale analyst Aneta Markowska says it is unclear how much fiscal restraint had been factored into the the Fed’s forecasts for next year, but it is evident that they have discounted very little fiscal tightening. This creates downside risks to the Fed’s current growth forecast:

“The near-3% forecast for next year could make it difficult to justify further easing, and incorporating more fiscal drag into the Fed’s central forecast may prove politically challenging. The best case scenario would be to see economic data soften just enough in the coming weeks to provide the necessary cover for further easing.”

The increased transparency has complicated the Fed’s scope to act preemptively. The best scenario for the Fed would be to see economic data soften enough in coming weeks to warrant further easing. The Fed could use potential downward revisions to Q1 GDP data, weak employment numbers, and European turmoil to justify further easing. 

Markowska for now is reiterating her call for a new round of monetary easing at the June 20 FOMC meeting, but thinks more signals will be needed before the meeting.

Don’t Miss: The Truth About The Fiscal Cliff >

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