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Getting the Fiscal Cliff Backwards
Jesse Richman, 9/13/2012

There was extensive media coverage of a recent Moody's warning concerning U.S. government debt ratings (issued September 11th) but most of it reflects a fundamental misunderstanding of the shape of the fiscal cliff, and of the nature of Moody's warning. 

For example, NPR stated

Today, Moody's sounded one more alarm saying if Congress remains in a stalemate, it would downgrade the U.S. credit rating from a AAA to a AA1.

While The Hiil (one of the three newspapers published for members of Congress and their staff) wrote

Moody's Investors Service warned Tuesday that Congress will need to strike a deal on the "fiscal cliff" to avoid a second downgrade to the nation's credit rating.

The rating agency said that budget negotiations in 2013 will likely determine the fate of the nation's credit rating, adding that an inability to strike a deal with "specific policies" to change the nation's debt trajectory would likely mean a downgrade. 

Many other news outlets (though there were some exceptions) took similar lines of argument, suggesting that avoiding the 'fiscal cliff' through a deal in Congress was key to avoiding a credit rating downgrade.  Almost nothing could be farther from the truth. 

The term fiscal cliff refers to the combination of two major policies changes due to go into effect in January 2013, and it also perhaps includes a fight over the debt ceiling.

1. The sequester.  Because the (not-so) Super Committee succumbed to partisan paralysis and couldn't come up with anything better, the sequester will begin making automatic spending cuts across domestic discretionary (50 billion per year) and defense (50 billion per year) programs. 

2. The Bush and Obama tax cuts will expire, along with a variety of other 'tax extenders' like alternative minimum tax relief.  In addition, the Medicare 'doc fix' is due to expire which would cut reimbursements for hospitals.

3. The term also sometimes includes the fact that some time soon the United States will once again reach the debt ceiling, requiring additional authorization from Congress before Treasury can resume borrowing money. 

The sequester, medicare and tax cut expiration will both have dramatically positive effects on the U.S. government's fiscal situation.   The consequences of going 'off the fiscal ciff' are depicted in the CBO projections shown in the figure.  The "Baseline Projection" if we go off the cliff is one in which the U.S. debt to GDP ratio soon begins to improve dramatically, walking the country back from the rapid increases in debt seen in the last few years. 

 CBO.jpg

If you believe the debt matters a lot, then going off the fiscal cliff is the most politically feasible way to solve the problem.  Instead of a deal being needed, all that is required is for Congress and the President to do nothing.   

What Moody's said was quite different from what the media reported. 

Moody's report was actually cautiously optimistic about the ability of GOING OFF the fiscal cliff to FIX U.S. budget problems. 

"Moody's views the maintenance of the Aaa with a negative outlook into 2014 as unlikely. The only scenario that would likely lead to its temporary maintenance would be if the method adopted to achieve debt stabilization involved a large, immediate fiscal shock—such as would occur if the so-called "fiscal cliff" actually materialized—which could lead to instability. Moody's would then need evidence that the economy could rebound from the shock before it would consider returning to a stable outlook."

Thus, going off the fiscal cliff would save the triple A bond rating, provided the economy doesn't collapse.  The fiscal cliff is a middle-range alternative among the set offered by Moody's.  The best would be if budget "negotiations lead to specific policies that produce a stabilization and then downward trend in the ratio of federal debt to GDP over the medium term, the rating will likely be affirmed and the outlook returned to stable"  The second best is going off the fiscal cliff.  The worst if if the Congress and President do what they are wont to do.  The CBO's "Alternative Fiscal Scenario" in which existing unsustainable tax and spending policies are sustained without effective plans to end or adjust them. 

Perhaps the entire discussion of the fiscal cliff has things a bit backward.  People talk of "going off" the fiscal cliff -- and the natural image is of the disaster that awaits one who tumbles from the edge of a precipice.  Instead, perhaps we should say "running into" the fiscal cliff -- the cliff thus a force that stops a tumble.  The fiscal cliff would reverse the slide of the government toward indebtedness.  Running into a cliff isn't fun.  It would raise nearly every-one's taxes.  It would cut spending on most of the programs everyone uses. And it would move the budget toward balance.  But it would keep us back from the precipice of the spendthrift alternative fiscal scenario.

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