A Gentler Slope for the Fiscal Cliff

Evan Soltas explains succinctly the tragic confusion in U.S. fiscal and monetary policy:

Federal Reserve Chairman Ben S. Bernanke, taking questions during a February House hearing on monetary policy, uttered two very special words: fiscal cliff.

“Under current law, on January 1, 2013,” Bernanke said, “there’s going to be a massive fiscal cliff of large spending cuts and tax increases.”

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Whatever Bernanke’s intention in February, Congress now works in fear of falling off his fiscal cliff. The irony is that while economic recovery rests largely in Bernanke’s hands, the tyranny of impending austerity is leading Congress toward poor decisions about the long-term structure of public spending and tax policy. These are mistakes monetary policy could never offset.

The cause of our cliff problem rests in the commingling of responsibility between fiscal and monetary policy in managing the economic recovery. A more mature way of doing business would charge the Fed with stabilizing demand in the short run and Congress with a structural environment conducive to the social welfare and economic growth over the long run. The U.S. is doing neither well right now.

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Long-term deficit reduction will also require substantial cuts to planned public spending, whether one assumes a return to the historical revenue average or something slightly higher than that to account for demographic change and health costs. This is particularly true beyond the budgetary “out-years,” or 20 to 30 years from now. At that point, federal promises on Medicare and Medicaid become unsustainable without large increases in tax revenue which raise fully a quarter of GDP. There is no reasonable scenario for sustainable public finances without deep rollbacks of spending promises beyond the out-years.

The austerity the fiscal cliff would achieve in one fell swoop would best be done gradually. Such an approach would be more in line with the real danger in our public finances, the combination of structurally low federal revenue and long-term increases in planned spending.

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