The rest of the plan involves spending cuts totaling more than US$1 trillion over the next nine years. Each government department will have its discretionary spending trimmed by 10 percent, although mandatory entitlements such as social security and Medicare would not be touched.
Democrats say that it would be foolish to cut spending when the economy remains weak, particularly given the poor state of the US’ public infrastructure.
“The basis for a deal to avert the fiscal cliff remains clear. Democrats are likely to agree to extend the tax cuts for high income earners in exchange for Republicans agreeing to delay the spending cuts,” US analysts at Capital Economics Paul Ashworth and Paul Dales said.
However, they added that this would amount to postponing the fiscal cliff without tackling the underlying problems and thus lead to further credit downgrades from the ratings agencies — Moody’s, Standard and Poor, and Fitch — early next year.
The US shrugged off losing its prized “AAA” rating last year, but the impact of a second downgrade might be to increase the cost of government borrowing and to push down the value of the US dollar.
Some fiscal tightening of policy is inevitable. Neither Democrats nor Republicans have expressed a desire to extend the payroll tax rebate holiday, while the cost of Obama’s healthcare plan will add US$18 billion to the nation’s tax bill next year.
Compared with the eurozone, where falling output this year is expected to be followed by a year of stagnation, the US is in reasonable shape. The economy is growing and US competitiveness is being boosted by cheap energy from shale gas. Some manufacturing capacity is being brought back to the US and there is the prospect of energy self-sufficiency within a decade.
However, in the short term the chances are that growth will remain sluggish and unemployment slow to come down. Deficit reduction, even if modest, will result in the US Federal Reserve keeping monetary policy ultra loose. Interest rates will remain at rock-bottom levels deep into Obama’s second term and the US central bank will consider further doses of quantitative easing to boost money supply.
This assumes the fiscal cliff can be avoided.
Obama won his second term despite what had happened to growth, jobs and living standards in the past four years. A majority of US citizens were unhappy about the state of the economy, but still gave the president a second chance. In the end, it was not the economy, stupid.
However, it is about to be.