The effects of a short-term 'cliff'

U.S. President Barack Obama holds a news conference on the fiscal cliff in the East Room of the White House Nov. 14, 2012 in Washington, D.C. - 

We’ve got some sense of what could happen, come Jan. 1, 2013, if the U.S. economy were to go over the so-called “fiscal cliff.” Taxes would go up. There would be automatic, across-the-board spending cuts. 

But what would happen if the U.S. economy were to go over that “fiscal cliff” -- then, just a couple weeks later, Congress and the White House were to reach a deal to change those tax rates, to do away with those automatic spending cuts?

What would those intervening two weeks be like? And what effect would that automatic austerity have on the economy?

Imagine you run a government agency. It’s New Year’s Day 2013, and there’s no deal.

“You slam on the brakes on any spending,” says Nicholas Bloom, an economics professor at Stanford.

You freeze payroll and adjust your budget. Then, the government reverses course.

According to Bloom, “That extreme stop-start is very damaging.”

It’s also hard. The government is big, and it is not nimble.

“Some programs have large lead times and involve major contracts, and those are very difficult to change quickly,” says Alice Rivlin, a former White House budget director, now affiliated with a campaign called Fix the Debt.

It could be a logistical nightmare for the private sector and corporate accountants if taxes went up, then down again two weeks later. 

And consumers would be spooked.  Andrew Busch, with BMO Capital Markets, says we’d live in fear, worried there could be another fiscal crisis, right around the corner.

“It’s really hard to make decisions on whether to move to a new home if you don’t know what your mortgage deduction is going to be like,” he says.

If the U.S. goes over the “fiscal cliff,” then claws its way back, what would the rest of the world think? Rivlin says we’d have to ask ourselves this question: “Does this make our government look so incompetent that people are not going to want to invest in the United States?”

And if the answer is “yes,” the effects of automatic austerity would last a lot longer than two weeks.

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