Tuesday, November 20, 2012

The Fiscal Cliff: Avoid it or take the plunge?

Dr. Kassens' Principles of Macroeconomics class spent the past week learning about debt and economic growth. In particular, they learned how government debt can crowd out private investment.

We investigated current statistics, including an analysis of the following graphs (generated by Dr. Kassens using the Federal Reserve Economic Data application). Click on the graph for a closer view.

As you can see, US debt to GDP ratio is over 105% after a long history of staying between 40-60%. A drastic increase occurred over the last four years. The debt is expected to increase during recession as government expenditures rise and tax revenues fall, but the recent debt/GDP increase is unprecedented.

Next, the class studied recent legislation and headlines regarding the debt, including the Budget Control Act of 2011 and sequestration. Congress built a fiscal cliff that the economy will go over January 1, 2013 if certain agreements are not met, including plans for significant debt reduction. The cliff is a mix of spending cuts (defense (~7.5%) and non-defense (~8.5% in affected discretionary programs, ~8.0% in affected mandatory programs excluding Medicare, and ~2.0% in Medicare)) and tax increases. Because the "Supercommittee" did not come to an agreement in 2011, we are set to step over the cliff at the start of 2013.

The class then split into groups and read the November 2012 CBO report about the impact of the fiscal cliff and possible alternatives on the economy in terms of changes in output and employment. The CBO expects that unemployment will rise to 9.1% and GDP fall by 0.5% if we go over the cliff, although they anticipate a recovery over the following years. ECON 122 noted that this increase in unemployment does not account for increases stemming from the implementation of PPACA's employer mandate. The CBO also provided several alternatives, including extending tax cuts for a year. These alternatives have a lesser impact on the labor market and GDP, at least in the short-term.

Finally, each group made a recommendation to Congress. Their choices included those outlined by the CBO. About half of the class recommended biting the bullet and jumping over the cliff. They cited several reasons:
1) The US is losing international credibility because it cannot get its financial house in order. Taking a bold step would send the signal that the government means business this time and is not just kicking the can down the road for another year.
2) The US's credit rating will only worsen with our current debt load and inaction. We need to take steps to correct this, else our interest payments will increase dramatically. Interest paid on the debt is money not spent on education, infrastructure, and other crucial domestic needs.
3) ENOUGH! These students realize that they are the generation that will bear the burden of the current debt and they want serious action.

The other groups argued that our economy is too fragile to accommodate such a drastic move and that the tax cuts should be extended for a year. In the meantime, Congress needs to get serious about making plans to right the economic ship and stop the continuous bickering.

As a professor, I was impressed with the sophistication of our discussions. These student may only have one semester of macroeconomics on their resume, but Congress would be wise to listen to them.

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.