The US economy

Common Ground Seen Holding U.S. Back From Cliff: Economy

The U.S. will avoid plunging off a fiscal cliff in 2013, according to economists surveyed by Bloomberg News, as lawmakers find enough common ground in budget negotiations to avert a recession

Bloomberg,

31 May, 2012.

This so-called cliff includes the expiration of income-tax cuts first enacted under President George W. Bush, the end of payroll-tax reductions and automatic decreases in government expenditures, which would clip a combined 3 percentage points from growth if allowed to kick in next year, according to the economists surveyed. Instead, compromises will limit the damage to 0.8 point, sustaining the expansion, the survey showed.

“Forecasters are pretty sanguine at the moment,” said Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania, who estimates the fiscal drag will shave 1.5 percentage points from growth next year. “While there will be a lot of brinksmanship and some tumult in financial markets as policy makers grind through this, at the end of the process they’re going to scale back that cliff significantly.”

Investors today focused on the situation in Europe as concern grew about Greece’s future in the euro and the health of Spanish banks. The Standard & Poor’s 500 Index dropped 1.4 percent to 1,313.32 at the 4 p.m. close in New York.

A report today showed economic confidence in the euro area declined in May to the lowest level in 2 1/2 years, and China’s state-run news agency yesterday said the country had no plans to introduce stimulus measures to support growth on the scale of those unleashed during the depths of the global crisis in 2008.

Probable Compromises

Tax breaks will probably be extended for most Americans and cuts in spending will be restrained, helping the world’s largest economy expand 2.4 percent next year, according to the median forecast of 46 analysts surveyed from May 22 to May 24. Gross domestic product will grow 2.3 percent this year, according to the median forecast of a larger survey taken earlier this month.

“If you go over the cliff, it’s a virtual certainty that we will have a recession in 2013,” said David Greenlaw, a managing director at Morgan Stanley in New York. “You have this strange situation, which is almost unprecedented, where you have a big, big change in policy if there is no action taken. It’s not the case where policy makers need to come up with something new. They just need to address what is automatically going to happen.”

The Bush-era tax cuts that were extended under the Obama administration and the temporary reduction in the Social Security payroll tax are among provisions that wrap up at year- end. More than $1 trillion in automatic budget cuts over the next 10 years are also slated to begin in 2013, and emergency and extended unemployment benefits will dry up.

Hit to Growth

The expiration of the programs means about $650 billion would evaporate from the economy, Greenlaw calculated. He projects lawmakers will extend the Bush tax cuts for most income brackets and reduction in government spending will be delayed, which would shave growth by 1 percentage point, he said.

The Congressional Budget Office said in a report this month that absent a compromise, the economy would probably fall into recession in the first half of 2013, contracting at a 1.3 percent annual rate. A pickup in the third and fourth quarters would lead to a 0.5 percent gain in gross domestic product for the full year, the CBO said.

Most economists surveyed by Bloomberg projected that Bush- era tax cuts will be extended for a majority of Americans, with the possible exception of top income earners. The scheduled spending cuts, known as sequestration, will also be delayed or made smaller, they survey showed.

Allowed to Lapse

The 2 percentage point payroll tax cut and emergency and extended unemployment benefits will, at the same time, probably be allowed to lapse, according to the survey.

History suggests lawmakers will not allow disputes to tip the economy into a recession. Over the past year-and-a-half, Congress has gone to the brink in negotiations over raising the debt limit and also funding the federal government. Each time, after much debate, policy makers have backed away from the edge, passing compromise legislation to keep the government running.

“The fiscal cliff case goes back to what happened last summer,” said Maury Harris, the chief economist at UBS Securities LLC in New York. “They kicked the can down the road. To me, the model of last summer is you postpone.”

Harris was among seven economists in the survey who project fiscal policy will not hurt economic growth. Polls show the economy is a more important election issue than the budget deficit, he said.

Government Gridlock

The presidential election may deepen the divide between the executive and legislative branches, which would increase the likelihood of a stalled decision-making process, Morgan Stanley’s Greenlaw said.

The threat of gridlock in Washington has also raised concern among policy makers at the Federal Reserve, including Chairman Ben S. Bernanke, who referred to the looming impasse as a fiscal cliff.

“If no action were to be taken by the fiscal authorities, the size of the fiscal cliff is such that there’s, I think, absolutely no chance that the Federal Reserve could or would have any ability whatsoever to offset that effect on the economy,” Bernanke said during an April 25 press conference.

Such uncertainty combined with Europe’s sovereign debt crisis gave central bankers “a quite reasonable case” for maintaining borrowing costs near zero through 2014, he said.

Congress needs to aim for long-run fiscal sustainability in a way that doesn’t endanger the short-term economic recovery, Bernanke said.

2012 Outlook

The lack of clarity surrounding the shift in government policies may influence companies before next year, said Michael Hanson, a senior U.S. economist at Bank of America Corp. in New York, who’s incorporated a slowdown into forecasts for 2012.

“A lot of people see the fiscal cliff as a 2013 story, but you don’t board up the windows when the hurricane is there, you board up the windows in anticipation,” Hanson said. “It’s a very clear, well-defined deadline when the fiscal cliff hits.”

Such ambiguity is among the “headwinds” holding back the recovery, Federal Reserve Bank of New York President William C. Dudley said today.

“The uncertainty about how Congress and the Administration will address the 2013 federal ‘fiscal cliff’ is likely to inhibit hiring and investment by business,” Dudley said in the prepared text of a speech in New York. He said the expansion will probably continue at a “moderate” pace and that additional stimulus likely won’t be needed unless the economy falters.

Spending Cuts

Preferred Systems Solutions is among government contractors already coping with delayed procurements and agency cost- cutting, said Scott Goss, president and chief executive officer of the Vienna, Virginia-based engineering and information technology provider. One intelligence agency asked Goss to lower his charges on an existing 10-year contract.

“I’m feeling more of a pinch and squeeze than I ever have before,” Goss said in an interview last week. “As soon as they start these massive cuts they’re going to impact the economy. They can’t just cut it like that. If they did, it will be devastation of biblical proportions.”