".... The fiscal cliff ..... At the end of this year several major budget items are scheduled to expire, including an extension of the Bush tax cuts, an extension of the stimulus payroll tax cut, and an extension of emergency unemployment benefits. At the same time, the "sequester" cuts to defence and health spending negotiated as part of last year's debt-ceiling compromise are also due to take effect. If all of these provisions are allowed to hit, the impact on the economy will be substantial.
..., says CBO. If all of the fiscal blow is deflected, the economy should grow at an annual pace of 5.3% in the first half of the 2013 fiscal year.
If Congress is unable to find a way to defer some of the impact, the economy will instead shrink by 1.3%
.Except, of course, that the economy will almost certainly not grow at a 5.3% rate no matter what Congress does. .... It is reasonable to assume.... the Federal Reserve has a general path for unemployment and inflation in mind and it will react to correct any meaningful deviation from that path. "
what .....that implies the present stag is more or less a chosen policy path
"A 5.3% growth rate is well outside the range of current Fed projections."
not projections are here equated with guidelines
"Growth that rapid would almost certainly bring down unemployment quite quickly, triggering Fed nervousness over future inflation and prompting steps to tighten monetary policy."
yup the stag's snail recovery of job markets is ..policy
" Growth might run slightly above Fed forecasts for a bit,
but the overall fiscal effect will be dampened considerably."
implication FED policy path is projected path
what the fed wants is what we get ...give or take quarterly wobbles
okay i'll bite
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"... do these dynamics play out in precisely the same way in the event that Congress fails miserably and allows a contraction equivalent to 4% of GDP to drop on the economy's head? "
in other words will the fed stick to the revealed preference path ie
assuming transparency and straight forward signals
the forecasted path
"In theory, they could. In practice, they generally don't. And under the present circumstances they really, really won't."
oh that was theory ...
never mind
-----------------------------------
wonderland update:
"Under ideal conditions, it should be relatively trivial for a determined Fed to offset even a fairly substantial fiscal blow."
" Imagine a typical household. In the event that Congress allows America to sprint off the fiscal cliff, this household will face an immediate reduction in take-home pay associated with the rise in payroll tax rates and a need to increase withholding to deal with a rise in marginal tax rates. That household will then find it necessary to reduce spending"
"(I'm ignoring intertemporal smoothing issues because they're probably too small to matter much and doing so makes the example much simpler). "
no comment
"In addition, businesses will curtail spending and investment based on the expectation that households will cut spending, generating a multiplier on the fiscal cuts sufficient to send the economy into recession."
"But cuts or no, there are plenty of agents in the economy that are not credit constrained. "
fine
"There is a rate of interest sufficient to encourage those agents to continue spending and investing such that overall demand doesn't fall and remain below trend. "
even if i stipulate that is true what if that real rate must be more negative
and we're at zero already ?
then
"The Fed .."can't ".. generate that rate of interest by cutting nominal rates"
so its gotta " influence inflation expectations. "
note not actual inflation ie not some how trigger an acceleration of product prices which makes todays real rate lower
nope
expected future inflation that maes expected real rates lower
"Alternatively, a credible Fed can simply promise to take whatever steps are necessary to maintain demand."
assume a can opener
"Under such circumstances, businesses will not cut in anticipation of a drop in demand, though they may shift investments in anticipation of a shift in demand from households to foreign markets."
i love this
the fed in wonderland
by i guess a deval forex policy can increase net exports in as much as it can't scrooge out more spending domestically by easier usury terms
in case this scenario seems shakey
we get this burning bush declaration:
"The central bank controls demand and can therefore offset fiscal actions."
oooops but that's wonderland
"In practice, central-bank control is imperfect. "
"There is uncertainty about the impact of both fiscal and monetary policy which will generate a margin of error."
" Both fiscal and monetary actions operate on a lag (itself uncertain) which magnifies policy uncertainty. In the real world, the multiplier is positive, and we would anticipate a contractionary effect from the fiscal cliff in expectation of and after its occurence which will be imperfectly dampened by the central bank."
"In this world, the dynamics are far messier. America is stuck at the zero lower bound, at which point the central bank can only influence the real interest rate by affecting expectations."
" I think there is a strong theoretical case that zero needn't be any more important than any other integer"
ahh theory scotches practical fears !!
" In practice, the Fed's reaction function appears to shift at the ZLB. The threshold for expansionary intervention seems to be higher at such times; until a negative shock translates into significant disinflationary pressure or financial distress the Fed stays its hand. "
ohh there is no liquidity trap
monetary policy just becomes more resident to expansionary policy
-- out of a mean sadistic fetishism ---
"There can be quite a large lag between the onset of falling real output and a drop in inflation,
especially (thanks to downward nominal rigidities) at low levels of inflation. "
"If the Fed becomes less responsive than normal, the fiscal multiplier rises. Imagine a world in which the Fed waits to see how Congress behaves and then waits until the economic impact of Congress' behaviour translates into falling inflation before stepping into action. Inflation may not depart from trend by all that much, but real output would likely dip substantially as a result of the fiscal cliff."
"But here's where things get really woolly. The Fed has tended to use a fairly mechanical sort of monetary policy through the recession and recovery, in which it observes the path of the economy and then pulls on this lever or that in an effort to influence borrowing costs or risk premiums, thereby moving the economy toward its desired growth path. But monetary policy is also about expectations—very much so. If the Swiss National Bank decides it wants to put a ceiling over the franc and doesn't tell anyone, it may end up printing and selling an awful lot of francs. If however, the SNB tells the world that it's going to defend at all costs a level of 1.20 swiss francs to the euro, then it may not have to do much heavy lifting at all. Markets may test the SNB and force it to sell francs in order to establish credibility. But markets know that it's fruitless to bet against a determined central bank with a printing press."
"The Fed could therefore proclaim to the world that will maintain aggregate demand growth (in the form of, say, nominal income growth) at all costs, and that it would by no means allow the fiscal cliff to knock the economy off its preferred path."
how ?
" It could explain in great detail what specific steps it would be willing to take to achieve this goal, so as to boost its credibility. And if demand expectations as reflected in equity or bond prices showed signs of weakening ahead of the cliff, the Fed could preemptively swing into the action to establish the credibility of its purpose."
"The Fed will almost certainly not do this."
fed could but fed won't
so no way to disprove efficacy of all this
"Why? Because the Fed is thinking about moral hazard, specifically, that if it promises to protect the economy against reckless fiscal policy Congress will have no incentive to avoid reckless fiscal policy."
" The Fed would very much prefer that Congress behave—lay out a plan for medium-term fiscal consolidation but keep short-term cuts small and manageable. It is therefore in the Fed's interest to imply that the fiscal cliff is a real economic danger, even if it could potentially prevent it from being one."
so the fed will become decptive
"The funny thing about this approach is that it neuters one of the Fed's more powerful policy tools. If Congress allows the economy to rush over the fiscal cliff despite the Fed's protestations, the Fed will ultimately do what it can to prevent a big drop in inflation and it would certainly prefer that unemployment not rise sharply. "
"But it will have spent months implying that its power to minimise the impact of fiscal cuts is limited (because if it isn't, why would the Fed be warning Congress about them?). Having done so, it will have a tough time convincing economic actors otherwise. Its interventions will be less effective as a result, and the fiscal multiplier will be quite large."
"A puzzle: why doesn't the Fed just do its job and try to convince markets that whatever Congress does about spending and taxes the demand side of the economy will be just fine?"
" If fiscal policy need not matter, why does the Fed pretend as though it does?"
"The answer, I think, is because fiscal policy does actually matter over the long run.
At one extreme, we can imagine a situation in which America's government has entirely lost market confidence and is unable to sell its debt. In that case, the central bank, as lender of last resort, would be unable to avoid stepping in to buy that debt, in the process transferring control over inflation to the fiscal authorities."
"To turn to something a bit closer to the realm of the plausible: imagine what happens when the economy begins running hot and the Fed starts raising interest rates. If the ratio of debt to GDP is above 100%, rising interest rates could have quite a damaging impact on the government's fiscal position. And that, in turn, could generate some interesting conversations in Congress. Perhaps the legislature would get its fiscal act together. Or perhaps it would threaten the central bank's independence."
ahhh so the fed doesn't want the debt barrier blasted thru by rampant fiscalists
"Fed independence is at any time little more than a useful illusion; it is only independent to the extent that its actions don't provoke government intervention."
" During the Great Moderation, there were well established norms concerning the ability of the Fed to manipulate the economy without much outside interference. The central bank is clearly less comfortable now, in a ZLB world where a broken Congress might well hit the economy with a 4%-of-GDP sledgehammer."
"In its own way, the Fed is facing difficulties not unlike those in Europe, where the European Central Bank is trying to shepherd euro-zone governments toward behaviours that minimise the chances that it will need to roll out dramatic, unconventional actions—the fear being, of course, that such actions would leave it hopelessly politicised and powerless to fight inflation."
yuponce the CB shows all these barriers arre made of paper and an eonomy can run itself along socially optimal paths without consulting the confidence of
privateeer for profit limited liability trans national corporations .....
".. In the end, both CBs are fighting to maintain their vulnerable independence.
And one price of that fight may be the need to occasionally allow fiscal policy to matter—as unfortunate Americans may soon learn "
get it
the fed has to not counter act
--even when it can --
a contraction triggered by fiscal action
the fed must feign impotence
so the congress won't make the fed a simple slave of fiscal action
--like for example the fed was from 1942 to winter 1951 --
