Fiscal cliff could help U.S. avoid road to Japan – but probably won’t

November 12, 2012

The “fiscal cliff” is widely seen as a massive threat looming over a fragile U.S. recovery. But with a little imagination, it is not difficult to see how the combination of expiring tax cuts and spending reductions actually presents an opportunity for tilting the budget backdrop in a pro-growth direction, even if political paralysis makes this scenario rather unlikely.

For Steve Blitz, chief economist at ITG in New York, the cliff presents a unique chance for the United States to avoid sinking deeper in the direction of Japan’s growth-challenged economy by shifting incentives away from consumption and towards investment:

If current negotiations end up simply turning the “cliff” into a 10-year slide an opportunity to help the economy regain a dynamic growth path and close the gap with pre-recession trend GDP would, in our view, be lost and raise the odds that, in the coming years, U.S. economic performance looks more like Japan’s. […]

Our tracking data show overall growth in an unsatisfactory 2% real growth path with weaker industrial activity threatening to pull growth lower.

The rebalancing of production and consumption must accelerate in order for the economy to regain a dynamic growth path. Macro policy is uniquely able to incent the economy in this direction and monetary policy has been doing its part. […]

Current negotiations to avoid the impending “fiscal cliff” create the opportunity to redirect economic incentives inherent in today’s budget.

For George Goncalves, fixed-income strategist at Nomura, the hit to growth is already occurring because of the heightened political risk that was once reserved for less stable emerging nations.

With the economy and markets hostage to politics and external factors for years now, hope of a better outcome has proven not to be a good strategy. We are deeply skeptical that the issues facing the nation will be resolved cleanly post election in the lame duck session. Even if there is compromise, damage to animal spirits has been done, which should result in lower growth in Q4 and Q1 2013.

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