The Fiscal Cliff
tl:dr: Don’t buy the hype.
My basic reaction is that there is a lot of kayfabe politics going on. Politicians need to cut the budget, but cutting the budget is unpopular, so they’ve set this huge stage up where they pretend to fight about and how it’s all contentious, etc, but in fact, they all really want to “fall off the cliff” as it were. The “bad” scenario is actually the good one. America can’t go on indefinately borrowing a trillion dollars a year. Congress did a ton of brain-dead policies in the last half dozen years and unfortunatly we’ve got to pay for them. That means higher taxes and lower spending. Well informed responsible people know this, Congress just needs to be a bit Straussian to sell it to the public.
The aggregate demand stuff is a red herring. My opinion is that the Fed is doing an amazing job stabilizing NGDP growth, but that they simply don’t care to return to the pre-2008 trendline. I can’t imagine that they will let AD collapse based on a predictable tax increase and spending cut when the economy is already so weak and they have made a promise to do whatever it takes to restore employment.
It’s important to have perspective throughout all of this. According to the CBO, it will raise 2013 tax revenue to 18.4% of GDP, and reduce spending to 22.4% GDP, still leaving a deficit of 4% of GDP. That’s not exactly austerity!
On the supply side, I’m not too worried either. I just don’t think there are a lot of positive externalities from most of government spending. I consider military spending to be mostly wasteful, as is the majority of the regulatory effort. Entitlements need to be cut, and it’s better to do that sooner rather than later in order to avoid getting swamped by demographics. It’s better to reduce someone’s benefit by 10% now than wait 20 years and have the whole system collapse, leaving everyone hanging out to dry. In conclusion, this’ll all be fun to watch, but it’s all sound and fury signifying nothing.
The wikipedia article on this is really good for background.
Update: Looks like going off the cliff is the best option.