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Thanks for avoiding that global recession, America. Now what?

By Tim Fernholz

A terse letter from the International Monetary Fund is all the thanks American politicians will get (or deserve) for avoiding a recession of their own making:


The IMF warned the US repeatedly to avoid the rapid fiscal consolidation of the “fiscal cliff”, making it one of two primary assumptions in its global growth forecast (pdf) for 2013. (The other assumption was that the European Union would not uravel under the pressure of financial crisis; so far, so good). Without those two key policy decisions, the IMF warned that the now-slowing expansion in emerging markets would not be enough to prevent a global recession.

The US avoided the bulk of the tax increases that would have held back growth, and adopted the relatively economically painless choice of raising taxes on the top 0.7% of earners, reducing its ten-year deficits by some $600 billion. And while the automatic $110 billion in spending cuts under the fiscal cliff have merely been postponed for two months to give Congress more time to haggle, if they do take effect the net drop in spending during this fiscal year won’t be large enough to force the country into a recession; it’s within the range of consolidation that the IMF’s economists expected. American consumers will still be buying goods from around the world, and housing markets are expected to bolster domestic activity.

But it’s not all gravy. In two months the US will hit its statutory borrowing limit. Congress will need to raise the limit or default on its payments. An inability to finance spending would mean immediate 40% cuts in government activity. Global markets could plunge as the safety of US Treasurys suddenly comes into question. Unlike the austerity threatened by the fiscal cliff, a debt default would be rapid and difficult to reverse.

Hence the second part of the IMF’s message:


That has a lot of people, especially liberals, worried. Republicans have voiced their plans to use the looming debt ceiling to force large spending cuts, while President Obama has warned that he won’t negotiate over America’s full faith and credit. But the arrival of the normal US budget deadline and the spending cuts sets up the framework for a sort of side deal, Congressional staff from both parties say: Congress and the President negotiate over spending cuts, which just happen to include an expansion of the debt limit.

Those negotiations will no doubt be hairy. Obama has angered conservatives by saying that whatever new agreement replaces the scheduled $110 billion spending cuts should contain a one-to-one ratio of spending cuts and tax increases. Republicans, having just okayed what is (for them, at least) a major tax hike, will want much bigger spending cuts. But after Congressional elections that accompanied the presidential ones in November there is a new, fractionally more moderate Congress, and the potential for changes to the Senate rules, which could create more opportunities for deal-making.

“From a budget wonk perspective, we can finally stop arguing about baselines,” Michael Linden, a fiscal policy expert at the Center for American Progress, says of the fiscal cliff fall-out. “Tax reform now becomes much more realistic now that we’ve gotten the rates back up to a reasonable level.”

That, though, could mean another postponement, with the new Congress trying to do what the last one couldn’t—find a balanced approach to fiscal consolidation.

Tim Fernholz
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