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      Analysis: Fiscal cliff could hit economy harder than many expect

      By Jason Lange

      WASHINGTON (Reuters) - The United States runs the risk of a recession far deeper than many investors and policymakers may think if lawmakers fail to avert looming tax hikes and cuts to public spending.

      Absent action by Congress, the country will face the so-called fiscal cliff at the start of next year, a combination of lower spending and higher taxes that is expected to extract about $600 billion from the economy.

      Many economists think every dollar of deficit reduction will subtract nearly the same amount from economic growth.

      By that measure, the current course could cause the economy to contract by 0.5 percent in 2013, according to estimates by the Congressional Budget Office (CBO) that have been largely embraced by Wall Street and the U.S. Federal Reserve.

      But research by economists in academia and at the International Monetary Fund suggests a dollar of deficit reduction could drain as much as $1.70 from the economy, making the prospective belt tightening much more dangerous.

      "You can take that 0.5 percent contraction and double it," said Barry Eichengreen, an economist at the University of California, Berkeley.

      These researchers suspect fiscal contractions take a bigger-than-normal bite from economies when interest rates are very low, as is the case at the moment in the United States and in much of the developed world.

      One explanation, Eichengreen said, is that when rates are higher, central banks can easily lower them to provide a counterweight to austerity. But when rates are near zero, as they are in the United States, it's harder to ease the pinch.

      Historical data suggests higher taxes or lower government spending normally lead households to cut back on purchases only modestly. In the three decades through 2009, a dollar in government austerity would suck only half that from the economy, according to IMF research published this month which examined fiscal policy in 28 countries.

      But economies around the world appear to be acting differently since the Great Recession. The IMF said it appeared that every dollar of recent fiscal consolidation has drained anywhere from $0.90 to $1.70 from economies.

      The IMF said this suggested central banks have been having difficulty offsetting the impact from tighter budgets.

      That could well be the case in the United States as well. The Fed pushed overnight rates to near zero in December 2008 and has resorted to the unconventional policy of purchasing government and housing-related bonds to revive the economy.

      The central bank's chairman, Ben Bernanke, has acknowledged he would not be able to fully offset the pain if the economy runs into the "fiscal cliff."

      With the U.S. jobless rate at 7.8 percent and the recovery still shaky, the possibility of a greater-than-expected hit to activity might be food for thought for lawmakers, who will be looking to cut some sort of deal on the budget before year end.

      LET'S MAKE A DEAL

      There's little room for error. Forecasters expect economic growth next year of just 2.1 percent, with the jobless rate edging down only slightly.

      As it is, economists believe even the level of danger outlined by the nonpartisan CBO will be enough to propel lawmakers, who are deeply divided over taxes and spending, to reach an accord, although signs have yet to emerge that a deal is starting to gel.

      "No political party wants to go down in history as the one that triggered the second half of the worst recession since the Great Depression," said Paul Dales, an economist with Capital Economics in London.

      Capital Economics expects Congress will allow just under $100 billion in fiscal tightening, which it thinks would knock the same amount off gross domestic product (GDP).

      Yields on U.S. government debt suggest investors as a whole are betting on even less tightening next year, according to research by analysts at Bank of America.

      Bank of America itself expects lawmakers will allow much of the fiscal cliff to transpire, leading to about $325 billion in budget tightening, enough in their view to stall job growth.

      Like Capital Economics and many other research units in the financial world, Bank of America presumes every dollar of tightening would drain the economy by about the same amount, although it says a bigger effect is possible.

      "The economic impacts could be worse than our baseline assumptions," said Michael Hanson, an economist with the bank in New York.

      Eichengreen and others who have studied economic data from the Great Depression, another time central banks were constrained, found the drag from a tightening of fiscal policy was much higher at the time. Eichengreen thinks currently the so-called multiplier is about 1.7, in line with the upper range of the IMF's estimate.

      If he is right, even avoiding just half of the fiscal cliff would not be enough to steer the economy clear of recession.

      Earlier this month, Senate Republican leader Mitch McConnell argued for not "a penny less" than $109 billion in budget tightening next year. But even a tightening in the budget of that magnitude would have an outsized effect if Eichengreen and others are on the mark.

      "It would make more sense to assure a strong self-sustaining recovery before embarking on significant fiscal consolidation," Goldman Sachs economists said in a recent report that summarized research pointing to heightened risks of budget slashing.

      (Reporting by Jason Lange; Editing by Tim Ahmann and Sandra Maler)

       

      1,503 comments

      • John  •  56 mins ago
        If the election comes down to just Ohio time after time.
        We are doing something wrong
        • David 5 mins ago
          And ya think that Obama is going to get the job done ? I Don't think so ! he has run this country into the ground , Benghazi , Jeremiah Wright, Bill Ayers and you trust Obama with our Country with his association with these people and the debacle in Benghazi ! he has one motive that is make this a country a socialist country ! God Bless America! and the Heros in Benghazi!
      • Dan  •  1 hr 21 mins ago
        I believe that the biggest waste in government is paying part-time congressmen full-time wages for doing a half-arsed job.
        • spring 39 mins ago
          A Yahoo, The house has passed a lot of legislation such as 17 jobs bills that are sitting on Harry Reid's desk. Please try to know what you are talking about!
      • Robert  •  1 hr 3 mins ago
        It's time that Congress did their job and serve the American people. Politics needs to put aside!
      • Greg  •  1 hr 7 mins ago
        TERM LIMITS! Its the only way we have of focusing our representatives on dealing with the issues of the day vs. getting re-elected! The president has term limits, so should congress!
      • Jade  •  1 hr 2 mins ago
        I can't afford to pay more in taxes....
      • A Yahoo! User  •  1 hr 4 mins ago
        850 bases globally. Do we need every single one of them? Israel, Pakistan, Saudi Arabia. Do we need to continue grants to these countries? Japan and Germany both have a strong warrior culture. Can't these nations re arm so we can save the dough? I say before we cut soup kitchens for our own, we cut soup kitchens for other nations.
      • life in CA  •  1 hr 7 mins ago
        Let us hope both Republicans and Democrats will work together for the good of the country, no matter who wins.
      • Mary Pranksters  •  54 mins ago
        Getting people back to work in the private sector and thus increasing tax revenue and reduce demand for entitlements could do a world of good.
      • terry  •  1 hr 1 min ago
        Clean house in congress, vote them all out and start all over with a new crop!!!!!
      • copier  •  1 hr 45 mins ago
        Lesson # 1: Non partisan political statement here, just some facts.

        * U.S. Tax revenue: $2,170,000,000,000
        * Fed budget: $3,820,000,000,000
        * New debt: $ 1,650,000,000,000

        * National debt: $14,271,000,000,000
        * Recent budget cuts: $ 38,500,000,000

        Let's now remove 8 zeros and pretend it's a household budget:


        * Annual family income: $21,700
        * Money the family spent: $38,200
        * New debt on the credit card: $16,500
        * Outstanding balance on the credit card: $142,710
        * Total budget cuts so far: $385
        • mark a 5 mins ago
          So voting for obama, a known liar and probable murderer is better. A man who hobnobbed with known Communists, who learned under the hate filled rhetoric of Rev. Wright and others like him. A man who sat at the feet of the America hater frank Marshall Davis. You would rather have him than Romney? You are no American. You believe you are, but yiou are not. Location does not make you something.Sitting in your garage does not make you a car. I am sick and tired of self serving Liberals alwyas praising this gangster of gangsters. but why would they not, birds of a feather. this man will never be my President, I would rather my dog. To say he is human repulses me.I have a young son and I cringe when I think what this monster will do to our country if elected again. I will never look at a Democrat the same again. I will know in my heart what they truly are. TRAITORS.
      • Nemesis  •  47 mins ago
        Forward! Over that cliff.
      • tonyv  •  1 hr 21 mins ago
        I have a stupid idea. Let's live within our means and not overspend. Individuals as well as the govt.
      • The Millenium Man  •  1 hr 51 mins ago
        Media, America needs JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS, JOBS,
      • Castro  •  1 hr 54 mins ago
        Mass Communication = Mass Manipulation...

        America is in Trouble... HELP US, OHIO.
      • PH  •  1 hr 2 mins ago
        I have no problem cutting the Federal Government by 50%.
      • RBC  •  59 mins ago
        Oh good, the opinions of BofA and Goldman Sachs are being taken into account, wait weren't they some of those who caused the crisis?
      • BryanS  •  34 mins ago
        Store enough food for one year for each family member.
        Store guns and 1000 rounds of ammo per gun (to protect your food and family)
        Buy some physical silver, perferrably Silver Eagles.
        Get to know your neighbors, because they can be your ally or the person who wants to steal your food.
      • Private Joker  •  44 mins ago
        We cannot tax enough or cut spending enough to get out of the hole we are in. Because of our $16 TRILLION in unplayable debt our currency will collapse taking 401ks IRAs savings with it. Good luck and buckle up its going to get ugly. No matter who the next President will be we still have 125 millions Americans getting a check from the Federal govt supported by 65 million and an aging population adding 10,000 everyday to social security. Fewer working age Americans and fewer tax payers.
      • A A  •  58 mins ago
        Its coming to the point where the US will not have the money to rebuild if a catastrophic event occurs... And that is when REALITY will final hit.... that the US is BROKE.
      • LIJOE  •  13 mins ago
        Only in America could the government collect more tax dollars from the people than any nation in recorded history, still spend a trillion dollars more than it has per year for total spending of $7 million PER MINUTE, and complain that it doesn't have nearly enough money.
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