How will the looming fiscal cliff impact the US economy and job market?

[mheslep]

Does that include and/or is the difference based on the two wars? If I remember correctly, one of Obama's spending cutting claims was based on the winding-down of the wars. ...

I'm not sure from that source. The breakdown is here by programs, troop spending, operation & maintenance, but I'm not sure if Afghanistan spending included therein.

 

[mheslep]

or raise revenue 10% and cut expenses 20%,

or raise revenue 20% and cut expenses 10%,

or ?

Or, as proposed today by Geithner, the US gets the revenue increase of ~10% and on the spending side, zero. A $50B spending stimulus *increase* was proposed instead.

WASHINGTON — Treasury Secretary Timothy F. Geithner presented the House speaker, John A. Boehner, a detailed proposal on Thursday to avert the year-end fiscal crisis with $1.6 trillion in tax increases over 10 years, $50 billion in immediate stimulus spending, home mortgage refinancing and a permanent end to Congressional control over statutory borrowing limits.
...
In exchange for locking in the $1.6 trillion in added revenues, President Obama embraced the goal of finding $400 billion in savings from Medicare and other social programs to be worked out next year, with no guarantees.

 

[russ_watters]

Or, as proposed today by Geithner, the US gets the revenue increase of ~10% and on the spending side, zero. A $50B spending stimulus *increase* was proposed instead.

In exchange for locking in the $1.6 trillion in added revenues, President Obama embraced the goal of finding $400 billion in savings from Medicare and other social programs to be worked out next year, with no guarantees.

I trust that Obama will try just as hard to fulfill that promise next year as he has this year.

Or perhaps the law can be written in such a way as to clarify that "next year" means that the spending cuts are always a year away. At least that will enable the CBO to better take into account that they aren't ever going to happen.

 

[Astronuc]

Or, as proposed today by Geithner, the US gets the revenue increase of ~10% and on the spending side, zero. A $50B spending stimulus *increase* was proposed instead.

Well, I see from FY12 and FY13, that the requested revenue (tax receipts?) is increased from $2.469 trillion (enacted) to $2.902 trillion (requested), or approximately a 18% increase, yet the expenditures are projected to be about the same, or ~$3.8 trillion.

Of course 'next' year probably means next fiscal year FY2014, which begins October 1, which effectively means 2014.

 

[Borg]

The rhetoric coming from both sides this week sounds a lot like last year. I wonder what the odds are of them just punting the problem out another year again.

 

[mheslep]

The rhetoric coming from both sides this week sounds a lot like last year. I wonder what the odds are of them just punting the problem out another year again.

To my recollection, higher tax revenues were not on table last time. This time they clearly are, articulated in public. Spending cuts have not been put on the table in public for the Jan 1 fiscal cliff. None. Spending *increases* were proposed instead yesterday.

 

[mheslep]

Well, I see from FY12 and FY13, that the requested revenue (tax receipts?) is increased from $2.469 trillion (enacted) to $2.902 trillion (requested), or approximately a 18% increase, yet the expenditures are projected to be about the same, or ~$3.8 trillion.

Of course 'next' year probably means next fiscal year FY2014, which begins October 1, which effectively means 2014.

That Wiki revenue projection from the US budget includes a projection about what the future economy, as budget revenue projects do, so you can't disambiguate tax increases directly from that aggregated number.

 

[Astronuc]

That Wiki revenue projection from the US budget includes a projection about what the future economy, as budget revenue projects do, so you can't disambiguate tax increases directly from that aggregated number.

I wasn't asserting anything about taxes. Revenue could be from royalties from resources on federal land. However, miscillaneous sources and customs duties are only about 5% of revenue. The rest are taxes.

http://nationalpriorities.org/budget-basics/federal-budget-101/revenues/

While the official tax rate for most corporations is 35 percent, the effective tax rate—that’s the percentage of profits a corporation actually pays in taxes—varies enormously from one corporation to the next.5 That variation is the result of incredible complexity in the tax code as well as corporations’ varying exploitation of “loopholes” to avoid tax liability. Loopholes refer to provisions in the tax code that exempt certain activities from regular taxation. For example, multinational corporations can allocate profits to overseas operations and reduce their tax liability by doing so.

. . . .

There are numerous legal tax shelters the small businesses can use to reduce tax liability.

Meanwhile - a side story - Is Puerto Rico the Greece of the Caribbean?
http://finance.yahoo.com/blogs/daily-ticker/puerto-rico-greece-caribbean-141121081.html

Corporations have been granted favorable federal tax rules, e.g., exemptions or reductions for locating/operating in PR.

Interesting resource - https://www.jct.gov/publications.html

and somewhat relevant (wrt an agreement) - http://news.yahoo.com/very-different-lame-duck-lessons-2010-130055187--abc-news-politics.html

 

[mheslep]

I wasn't asserting anything about taxes. Revenue could be from royalties from resources on federal land. However, miscillaneous sources and customs duties are only about 5% of revenue. The rest are taxes.

...

I was mainly interested in pursuing the earlier suggestion of

or raise revenue 10% and cut expenses 20%,

which I find reasonable though I think the ratio should be at least three to one.

There seems to be some agreement on some revenue increases, but none on the expenses side. That is, not only are there no new expense cuts on the table for this year from the White House despite frequent use of the term 'balance'. The White House is instead proposing new [/I ]spending - $150B over three years w/ $50B in this first year.

 

[Astronuc]

I could swear I posted a response earlier today.

Anyway, I think the numbers warrant a reduction of 30% in expenditures over the current requested, with taxes (or revenue) enacted where they are. That would mean a severe reduction in government programs, including social security, Medicare and Medicaid, and the defense budget.

In the meantime, we would need to put on the order of 8 to 10 million folks to work doing something productive, and earning an income between $50K and $100K per year. Folks earning less than $50K don't pay much if any taxes, particularly if they are supporting families.

 

[SixNein]

I could swear I posted a response earlier today.

Anyway, I think the numbers warrant a reduction of 30% in expenditures over the current requested, with taxes (or revenue) enacted where they are. That would mean a severe reduction in government programs, including social security, Medicare and Medicaid, and the defense budget.

In the meantime, we would need to put on the order of 8 to 10 million folks to work doing something productive, and earning an income between $50K and $100K per year. Folks earning less than $50K don't pay much if any taxes, particularly if they are supporting families.

Do you not think it would be reasonable to take some of the money saved through cuts and stimulate through infrastructure spending?

I'm kinda cautious about Austerity. A big Austerity program right now could rape our economy. We are in a liquidity trap with interest rates at 0 which means the central bank is going to have trouble manhandling an austerity program. So we can't exactly count on the Fed to smooth everything over. And People will invest less now due to expected future cuts. The more severe those cuts are, the more blow-back we'll see in investment especially with programs with a fairly high multiplier effect.

I don't know if people understand what I mean by the multiplier effect. So I'm going to explain it real quick just in case.

Suppose the government spends 100 dollars. A person receives 100 dollars and saves 10 from the government. The rest is spent which becomes income for the next person. The next person receives the 90 dollars, saves 10, spends 80. And on and on and on. This creates a multiplier effect. So every dollar the government spends will usually create much more than a dollar in terms of GDP.

Tax cuts also have multiplying effects; however, it's not typically as strong as government spending. Highest income bracket usually has a fairly low multiplier while the lowest bracket usually has the highest multiplier.

The point being here that Austerity (especially during a liquidity trap) is not as simple or safe as some seem to think. Just because you cut 100 billion out of the deficit does not mean your budget will be 100 billion closer to black. These multiplier effects will tend to shrink the tax base; as a result, tax revenue will decline. So cutting spending does not go dollar for dollar towards a deficit. In addition, the federal budget could trigger more cuts at the state level adding to the multiplier effect. In a basic nutshell, Austerity comes with its own set of risks especially in the middle of a liquidity trap. And I don't understand why people aren't discussing them when they cough them up frequently for stimulus spending. We are only growing at around 2%, so we don't have a lot of wiggle room for mistakes.

 

[Astronuc]

Well, we could distribute the debt liability according to net wealth and income. The treasury could send out a statement with a list of options for a payment schedule - 1 yr, 2 yr, 5 yr, 10 yr, . . . .

 

[SixNein]

Well, we could distribute the debt liability according to net wealth and income. The treasury could send out a statement with a list of options for a payment schedule - 1 yr, 2 yr, 5 yr, 10 yr, . . . .

Congress needs to plan everything around multipliers and not ideology. I'd raise taxes on people with the lowest multipliers, make reforms to control growth rates on future spending with programs like medicare and military, and stimulate the economy through investments in infrastructure with some of the savings. The infrastructure will expand the tax base and should provide a source of long term revenue for the government (it's what 2 trillion behind now?).

If we just ignore multipliers and allow our infrastructure to continue to degrade, we are going to severely damage our economy. We can't run a top economy on a 3rd world infrastructure. The risk here is that we end up in a nasty spiral that is very hard to pull out.

 

[SixNein]

Congress needs to plan everything around multipliers and not ideology. I'd raise taxes on people with the lowest multipliers, make reforms to control growth rates on future spending with programs like medicare and military, and stimulate the economy through investments in infrastructure with some of the savings. The infrastructure will expand the tax base and should provide a source of long term revenue for the government (it's what 2 trillion behind now?).

If we just ignore multipliers and allow our infrastructure to continue to degrade, we are going to severely damage our economy. We can't run a top economy on a 3rd world infrastructure. The risk here is that we end up in a nasty spiral that is very hard to pull out.

On second thought, I think congress needs to pass an infrastructure stimulus bill now. I think it's just too dangerous to do Austerity right in the middle of a liquidity trap. Congress instead needs to focus on getting the US to full employment so the interest rates start lifting. At that point, the US needs to follow up with Austerity, and the central bank can then smooth things out so that it doesn't do too much harm to the economy.

 

[Oltz]

SixNein this is one of the rare times I agree with you in a way

The only increased spending I would accept would be infrastructure roads/bridges/dams water/sewer/gas/power line work is so lacking we are due for some major repair that state and local governments just have not been prudent enough to undertake over the last 30 years.

But I would achieve that by ~10% increase in revenue ~30% cut in spending across all programs and redirect 15% of that to infrastructure projects with the caveat that no funding goes to new projects all of it goes to repair/replace/maintain projects with full bidding and distributed to each representative district to eliminate the desire for pet projects.

No high speed rail until we get what needs fixed taken care of and every district in the country needs work giving it to the state governments will only see the "city" issues fixed leaving dams and distribution lines in the rural areas untouched.

I would run this program and those cuts for at least 5 years but would push for 10.

 

[SixNein]

SixNein this is one of the rare times I agree with you in a way

The only increased spending I would accept would be infrastructure roads/bridges/dams water/sewer/gas/power line work is so lacking we are due for some major repair that state and local governments just have not been prudent enough to undertake over the last 30 years.

But I would achieve that by ~10% increase in revenue ~30% cut in spending across all programs and redirect 15% of that to infrastructure projects with the caveat that no funding goes to new projects all of it goes to repair/replace/maintain projects with full bidding and distributed to each representative district to eliminate the desire for pet projects.

No high speed rail until we get what needs fixed taken care of and every district in the country needs work giving it to the state governments will only see the "city" issues fixed leaving dams and distribution lines in the rural areas untouched.

I would run this program and those cuts for at least 5 years but would push for 10.

Well I think the sequencing of these events needs to be thought about very carefully. Does it make sense to do Austerity in the middle of a liquidity trap? The fed cannot get us to full employment nor can it protect us from shocks to the market with interest rates stuck at 0.

So why not try to piggyback the economy off of an infrastructure spending bill while interest rates are so low? It's not as if we can simply afford to ignore infrastructure forever.

If the infrastructure bill worked, it would start bringing the economy back to full employment; as a result, interest rates would rise and get the banks out of the liquidity trap. At that point and time, Austerity would be less risky than it is today. And I totally agree with you, we need our infrastructure upgraded without leakages to pet projects.

 

[Astronuc]

In the plan, Republicans offer a total of $2.2 trillion in deficit reduction over the next decade. That would give lawmakers "ample" savings to off-set $1.2 trillion in automatic cuts set to begin to take effect Jan. 2, 2013. Senior Republican aides said the proposal does not explicitly include an offer to address the standoff over whether the president or Congress should have power over debt limit increases.
. . . .
The offer also proposes $600 billion in health savings, $300 billion in additional mandatory savings, $300 billion in discretionary spending cuts, and $200 billion by updating the formula by which the Consumer Price Index is calculated, which would affect all sorts of federal programs from Social Security to federal pensions.
. . . .

http://news.yahoo.com/boehner-makes-fiscal-cliff-counter-offer-201946665--abc-news-politics.html

Only $2.2trillion over 10 years? In other words, we still have a deficit and increasing debt. And when ten years go by, they'll still be talking about a deficit? And the debt will be $20+ trillion? And the interest on the debt will be $400+ billion/yr, or perhap $500+ billion/yr?

http://www.treasurydirect.gov/govt/reports/ir/ir_expense.htm

http://www.foxnews.com/politics/201...unting-firm-us-debt-crisis-bigger-than-think/

That's because interest payments add a whole new level of fiscal pain to the country's debt problem. Interest payments on the national debt alone, it noted, are expected to total some $4.2 trillion over the next decade.

Here's a different projection - http://money.cnn.com/2012/03/05/news/economy/national-debt-interest/index.htm

The U.S. government’s interest expense fell to the lowest in seven years as yields on Treasury debt dropped to records even as debt soared beyond $16 trillion for the first time, aided by a one-time accounting change.
. . . .
The fiscal 2012 interest bill was reduced by a change in Department of Defense accounting methods for market-based securities, a one-time adjustment of $75 billion for the month of July. Without the adjustment, the interest bill would have been the lowest since $414 billion in fiscal 2010.
. . . .

http://www.businessweek.com/news/2012-10-04/u-dot-s-dot-interest-cost-falls-to-lowest-since-2005-as-debt-soars

 

[Galteeth]

I'm all for the fiscal cliff. Let people finally start to take the problem seriously. I'd rather have a bad recession/depression for two years then collapse of the dollar (and hence the world economy) down the road.

 

[russ_watters]

"Than", not "then". Changes the whole meaning...

But yeah, I agree. People don't take debt seriously until there are obvious consequences to the debt. We can either wait until we do a Greece or start sucking up an dealing with it while it is still a recoverable situation.

 

[SixNein]

I'm all for the fiscal cliff. Let people finally start to take the problem seriously. I'd rather have a bad recession/depression for two years then collapse of the dollar (and hence the world economy) down the road.

What is the point of worrying about debt if one is simply going to pull out a gun and shoot the economy anyway?

The liquidity trap is the most important problem we have in our economy right now. And the central bank cannot escape it on its own. If your worried about inflation on the dollar, the liquidity trap is the problem.

Federal Reserve Bank of Chicago President Charles Evans said further monetary stimulus is needed now to help the U.S. economy escape from a “liquidity trap.”

“There is simply too much at stake for us to be excessively complacent while the economy is in such dire shape,” Evans said in prepared remarks for a speech today in Muncie, Indiana. “It is imperative to undertake action now.”

http://www.businessweek.com/news/2011-12-05/fed-s-evans-says-imperative-for-fomc-to-escape-liquidity-trap.html

What about fiscal policy? As Mike pointed out in his earlier paper, fiscal stimulus in a liquidity trap doesn’t require that you convince the market that you’re going to behave differently once the crisis is past. It doesn’t depend on expectations at all; the government just goes out and creates jobs. So it made a lot of sense to argue for stimulus as the main immediate response to the slump.

But isn’t fiscal stimulus also a hard sell politically? Yes, indeed – although the truth is that we did get some, and it probably had a major impact in softening the economic blow. And we would have had more if not for the scorched-earth opposition of Republicans, which is not a problem of economic analysis.

So what should well-meaning economists do now, with both fiscal and monetary policy falling short? The answer is, campaign on both fronts, trying to convince influential players both that austerity is wrong and that the Fed needs to start signaling its willingness to see more inflation before it raises rates.

http://krugman.blogs.nytimes.com/2012/09/01/monetary-versus-fiscal-policy-revisited/

 

[SixNein]

"Than", not "then". Changes the whole meaning...

But yeah, I agree. People don't take debt seriously until there are obvious consequences to the debt. We can either wait until we do a Greece or start sucking up an dealing with it while it is still a recoverable situation.

Do you think we should just ignore the liquidity trap then? I would also point out that Greece's problems are a bit different from Americas.

 

[mheslep]

Well, we could distribute the debt liability according to net wealth and income. The treasury could send out a statement with a list of options for a payment schedule - 1 yr, 2 yr, 5 yr, 10 yr, . . . .

Even that extreme measure will *not* stop the accumulation of more debt via entitlement spending. Why not address the problem directly?

 

[russ_watters]

What is the point of worrying about debt if one is simply going to pull out a gun and shoot the economy anyway?

I'd rather have temporary pain than permanent pain.

The liquidity trap is the most important problem we have in our economy right now. And the central bank cannot escape it on its own. If your worried about inflation on the dollar, the liquidity trap is the problem.

No, that doesn't have much of anything to do with the federal budget debt negotiations that I can see. Federal Reserve "stimulus" is not the same as federal government spending "stimulus".

Also, that article is a year old and the Fed has since done QE3.

I would also point out that Greece's problems are a bit different from Americas.

I would say that theirs are of the same nature, differing mostly in degree: Too much deficit spending on social programs, leading to too much debt.

 

[russ_watters]

Even that extreme measure will *not* stop the accumulation of more debt via entitlement spending. Why not address the problem directly?

Agreed. Slowing the accumulation (stopping it) is a much bigger issue - and a prerequisite, imo - than paying off what we have now.

 

[mheslep]

I'm all for the fiscal cliff. Let people finally start to take the problem seriously. I'd rather have a bad recession/depression for two years then collapse of the dollar (and hence the world economy) down the road.

"Than", not "then". Changes the whole meaning...

But yeah, I agree. People don't take debt seriously until there are obvious consequences to the debt. We can either wait until we do a Greece or start sucking up an dealing with it while it is still a recoverable situation.

Even going over the "fiscal cliff" will not make the deficit sustainable, as the cliff does nothing to reduce entitlement spending. The cliff does kick the can down the road, probably far enough to make it the next President's problem at the consequence of putting the economy in the tank for the next several years.

 

[mheslep]

http://news.yahoo.com/boehner-makes-fiscal-cliff-counter-offer-201946665--abc-news-politics.html

Only $2.2trillion over 10 years? ...

Yep, and which was immediately rejected by the White House.

White House spokesman Dan Pfeiffer criticized it for not meeting "the test of balance." Another Obama spokesman, Jay Carney, earlier said the president "will not sign a bill that extends those tax rates for the top 2%," as the GOP proposal would do.

Mentioning "balance" is risible, as the WH proposal is all increased taxes with net increased spending.

 

[russ_watters]

Even going over the "fiscal cliff" will not make the deficit sustainable, as the cliff does nothing to reduce entitlement spending. The cliff does kick the can down the road, probably far enough to make it the next President's problem at the consequence of putting the economy in the tank for the next several years.

Different "deficit". Yes, I'd like entitlement spending to be reigned-in, but the budget deficit is more immediate. Last I heard, Social Security will be unable to meet even the current pathetic promises by around 2037, but the federal budget won't make it to 2020 without reducing the deficit.

And even then, if SS and Medicare overrun, the government can simply change the rules and make them even worse deals than they are now. But that won't cause the economy to collapse. But if we keep running up debt and interest rates start to rise, our government will go bankrupt like Greece.

I've pretty much written those programs off. I'm trying to plan as if they completely cease to exist before I reach retirement age and I have to live off my own savings.

 

[Borg]

...I've pretty much written those programs off. I'm trying to plan as if they completely cease to exist before I reach retirement age and I have to live off my own savings.

Ditto on that. I've been telling my wife not to expect anything by the time that either of us retires. Sadly, those of us who are planning for this eventuality and saving will probably be hit by a means test - if the programs are still around. I say sadly not because I'm against doing my part but because it would be necessary because of the stupidity of the politicians.

 

[mheslep]

Different "deficit". Yes, I'd like entitlement spending to be reigned-in, but the budget deficit is more immediate.

Agreed. By sustainable, I mean that while tax increases and a couple hundred billion in cuts per the fiscal cliff will lower the deficit some immediately, the improvements will be eaten up again soon by federal healthcare and pension spending as it continues to explode.

Last I heard, Social Security will be unable to meet even the current pathetic promises by around 2037, but the federal budget won't make it to 2020 without reducing the deficit.

Those SS timelines a couple decades out are based on payment on loans from the SS trust fund to the rest of the government; in other words the repayment is the left hand of the government paying the right. Current SS income from outside the government does not pay for SS outlays *today*.

Social Security’s expenditures exceeded non-interest income in 2010 and 2011, the first such occurrences since 1983, and the Trustees estimate that these expenditures will remain greater than non-interest income throughout the 75-year projection period.

Which means that, like all federal spending, it is increasingly dependent on issuing debt to continue. If lenders decide to stop lending, then all SS is subject to failure, or payment in cheaper dollars, along w/ the rest of federal spending.

 

[russ_watters]

Those SS timelines a couple decades out are based on payment on loans from the SS trust fund to the rest of the government; in other words the repayment is the left hand of the government paying the right. Current SS income from outside the government does not pay for SS outlays *today*.

My reading of that is that SS outlays exceed the tax revenue. But that doesn't mean that SS is being funded from general tax revenue: it has its own trust fund, which is still growing:

According to the Social Security Trustees, who oversee the program and report on its financial condition, program costs are expected to exceed non-interest income from 2011 onward. However, due to interest (earned at a 4.4% rate in 2011) the program will run an overall surplus that adds to the fund through the end of 2021. Under current law, the securities in the fund represent a legal obligation the government must honor when program revenues are no longer sufficient to fully fund benefit payments. However, when the trust fund is used to cover program deficits in a given year, the Trust Fund balance is reduced. By 2033, the fund is expected to be exhausted.

http://en.wikipedia.org/wiki/Social_Security_Trust_Fund

The date was moved up to 2033, though...

And don't get me wrong. It needs to be fixed -- scrapped, even. The program has already failed at its primary purpose, which is providing retirement investment savings for workers. It no longer provides investment growth for most people. Since most of that is in increased taxes, not reduced benefits, basically it means it is reducing the standard of living of today's Americans to pay back the debts of of our grandparents, who paid in very little and took a lot.

 

[Astronuc]

From the Wikipedia article - "As of April 2012, the intragovernmental debt was $4.8 trillion of the $15.7 trillion national debt." So they've been financing government functions off funds allocated for future retirement security.

In theory, I have about $250K in my SS account (from my and corporate contributions). I'd like to transfer it to my kids, since I won't need it.

 

[russ_watters]

From the Wikipedia article - "As of April 2012, the intragovernmental debt was $4.8 trillion of the $15.7 trillion national debt." So they've been financing government functions off funds allocated for future retirement security.

Yes they've been raiding the SS trust fund to fund general government functions, not the other way around. At least it means we aren't paying 3rd parties (the Chinese?) interest on that splending, but we also aren't earning interest on it either.

Anyway, it means that fixing the normal debt will also help SS.

In theory, I have about $250K in my SS account (from my and corporate contributions). I'd like to transfer it to my kids, since I won't need it.

It would be nice if that were possible, but the program has been so mismanaged that it can't remain solvent without taking it from people who won't need it or have died young. Best bet? Take the money, invest it yourself and give it to them later.

 

[Alfi]

The more I read about this 'cliff' the more I like it.

These people that get paid a lot of money to do their jobs are being forced to do their jobs or actions will occur without them. At this point I think they should all be fired.
Simple case of failure to perform the job they were payed to do.

As Trump would say ... You're Fired.

 

[ImaLooser]

The more I read about this 'cliff' the more I like it.

These people that get paid a lot of money to do their jobs are being forced to do their jobs or actions will occur without them. At this point I think they should all be fired.
Simple case of failure to perform the job they were payed to do.

As Trump would say ... You're Fired.

The Rs seem to be stuck. They have been advocating cutting spending ever since they lost the power to direct increased spending to political allies. But they don't want to take the political hit of actually cutting spending. How can they wiggle out of it, since they control the House which controls spending? I dunno, but they sure will try. What they want to do is cut taxes for the rich and say that this will boost revenue so much that no spending cuts will be necessary. But Mr. Veto says no dice.

"Everybody tells me, they want to raise taxes and cut spending. But what they really mean is, they want to raise the other guy's taxes and cut the other guy's spending." -- President Bill Clinton.

 

[SixNein]

I'd rather have temporary pain than permanent pain. No, that doesn't have much of anything to do with the federal budget debt negotiations that I can see. Federal Reserve "stimulus" is not the same as federal government spending "stimulus".

Also, that article is a year old and the Fed has since done QE3.
I would say that theirs are of the same nature, differing mostly in degree: Too much deficit spending on social programs, leading to too much debt.

There is quite a few things to address here. First, I'm not sure if you are confusing a government budget with a household budget. In economics, they are very different animals, and one mustn't confuse the two.

Second, I think it's important that we categorize America's problems into three groups:
1. Short term problems.
2. Medium term problems.
3. Long term problems.

1. Short term problems:
We are not running at full employment, which means that our economy is running under capacity. Unemployment is high, and it will likely continue to be high through next year. In addition, our market is stuck in a liquidity trap. A liquidity trap means that the fed is unable to influence aggregate demand with monetary policy because interest is up against the zero constant. As such, the federal reserve cannot bring the economy back to full employment on its own; as a result, our economy is stuck in stagnation. And like Japan, it can last a pretty long time. This is why the central bank is important to discuss.

We are also still at risk of shocks to the market. Oil prices could increase causing input costs for firm to rise which results in slower economic growth and potentially more unemployment. In addition, weather events like Katrina could cause disruptions which causes input costs to rise.

We are also at risk from a EU collapse. While our exports losses to the EU would be a small hit, the financing the EU does in Latina America would be much larger and unpredictable hit to our exports.

China is pumping up a credit bubble of its own which could pop. Obviously, this would be bad for the American economy. And it may very well happen.

Perhaps the greatest short term risk is our political system. Politicians are creating enormous uncertainty in the market which could trigger a lack of confidence in America. For example, the "fiscal cliff" could better be defined as a "fiscal slope" to take some of the shock out of it in the market. The integration over the year of the fiscal cliff is what makes the policy a cliff. It cuts too much, too quickly, and too soon. But the greater threat is the expectations of the market created by the doomsday economic talk of our politicians which gets echoed over and over again in the media. As a result, they have created an unnecessary risk to the US economy. The expectations of the market could be very negative if we go over the cliff deadline since most are calculating that congress will avoid it, and they are frequently reminded of the impending disaster if it passes. But the actual truth is that congress has time even if the deadline is passed to prevent damage to the economy; however, the perceptions of the market is now a risk that could have been avoided.

The private debt collected during the bubble is likely a drag on the economy. People are paying off debts (if they are working) instead of buying things or investing in things. Obviously, this activity depresses aggregate demand.

2. Medium term problems.

The high debt accumulated as a result of the recession is a threat to the medium term economy. The threat is big because it can and will crowd out the market. In addition, government spending on necessary items may be neglected. The worse case scenario is a loss of confidence in the bond market which would cause yields to skyrocket.

The federal reserve runs a risk of loosing it's Independence. When and if the economy returns to full employment, the federal reserve may very well have a negative balance sheet due to its quantitative easing program. Even though the fed has a lot of tools at its disposal to effectively deal with the negative balance sheet (and it pays in its own currency), congress may use the negative balance sheet as an excuse to take away the fed's independence. (which would scare the living heck out of me).

3. Long term problems.
The largest long term problem is our growth rates on taxation and spending. Taxation seems to be in decay while spending seems to be growing rapidly. The government cannot tax like a small government but spend like a large government. To do so, the budget formula (taxes - outlays) will be negative and will contribute annually to our debt. Eventually, the markets will lose all faith in our debt. What nations are unable to pay won't be paid.

Our infrastructure is in really bad shape, and it will start dragging the economy down. As I said in another post, a nation cannot run a #1 economy on a third world infrastructure.

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So now I'm going to give a more detailed explanation of what congress needs to do but probably will not do.

First, Congress needs to announce that it is finally resolved to bring the economy back to full employment (read stimulus). It should announce it will do everything in its power to put American men and women back to work. This must be congresses first priority. As I said above, the fed is unable to act meaningfully to get us back to full employment on its own. Fiscal policy and not monetary policy is gong to be the main driver of where we go from here.

Second, congress needs to lay out reforms to various programs such that the growth rates are negative until they reach a sustainable point. In addition, taxation needs to be reformed such that taxes are positively growing until it reaches a sustainable point. These policies should come together to show that the American budget will eventually cross the equilibrium and reach a surplus. Spending cuts to programs with high growth rates are only temporary solutions. Congress needs to do reforms not cuts to solve the problem of high growth rates.

Third, Congress should make cuts where necessary. Foreign policy needs to be realigned such that it is economically sustainable in the long term. The military should be scaled back according to such policy. At this point and time, I think the military is quite overextended and our investments are probably not optimal.

Fourth, Congress needs to create various stress test and safety valves on policy effecting the economy. For example, spending cuts over a period of time should be interrupted if these stress test come back bad. These safety valves should help lift market expectations of the future. It will give them a clear message that congress is fully committed to ensuring it reaches full employment, and it is also going to be responsible about its debt.

In conclusion,

Congress has to deal with the immediate problems first. But it also needs to communicate clearly that it will be responsible in dealing with the medium and long term threats to the economy. Plans should be created with safety valves to give the market some insurance on its future expectations.

And I fully disagree with crossing the fiscal cliff or doing any kind of deep spending cuts right now. What are the benefits and risk of it? The benefit is a temporary relief of debt accumulation and the risk is economic suicide.