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Fiscal Cliff: Transforming Today’s Headwinds to Tomorrow’s Tailwinds 

economy for Ken

Interview by Rachel Duran

With the fiscal cliff looming, Ken Goldstein, an economist for The Conference Board, weighs in as to where the economy stands and says austerity measures are on the way.

Rachel Duran: What does the latest Leading Economic Index say about the economy?

Ken Goldstein: This is a glass half, full half empty story in the sense that the U.S. economy, at the moment, and perhaps for much of the first half of 2013, will continue to feature weak expansion. The good news in regard to the fundamentals of the U.S. economy, is there is no sign, absent the fiscal cliff, that the United States will fall into contraction.

We are limping along economically until we see enough progress in the housing market, which may happen by spring. If we are unlucky it may take until the summer. Improvement in the housing market, lending support to the labor market, is likely to produce a better second half in 2013 than the first half.

On the down side, not about the economy, but in terms of what is developing or not developing in Washington, D.C., is arriving at an agreement on revenue and spending.

There is so much misinformation out there. The essential point of all of this is that we are spending, at the federal level, 22 percent or more of GDP. We are taking in revenue of 18 percent or less. Now you don’t need a Ph.D. in accounting to know that if you spend at 22 percent and earn at an 18 percent rate, you will steadily pile up more debt.

What is driving this impetus to get the federal budget more into balance is some drive to limit spending, rein in spending, and some drive to find more revenue. And we have been hearing day after day that this means raising rates or closing loopholes or taking other measures.

So we are talking about introducing into the United States some degree of austerity. We have been doing this at the state and local level across the country for the last four years.

In some parts of the country, such as California, Michigan and New Jersey, we have been through severe austerity. Other states such as Oklahoma and Texas haven’t had to resort to an austerity program of that magnitude because they have other sources of revenue.

For example, some of the states in the Southwest United States generate their revenue from the minerals industry; the energy industry and the non-energy mineral industry.

So, the condition of the economy going into 2013 is that on top of the ongoing multiyear austerity regime in many states, we are about to enter some degree of austerity at the national level and we are arguing how much comes off of spending, how much comes off of revenue.

The big point is when does all of this kick in? In the economy right now, in the fourth quarter of this year and the first quarter of next year, we are going to grow by less than 2 percent; perhaps less than 1.5 percent.

Most economists, not most politicians, might say: ‘This might be the right program but this isn’t the right time to begin it. Wait until the economy gets above a 2 percent or 2.5 percent rate of growth and then begin an austerity program.’

In fact, one of the proposals, whether it is enacted, deals with not only not implementing austerity now but to actually implement stimulus now, than offset it with austerity measures at a later date.

The fundamentals of the U.S. economy are sound but not strong enough right now to deliver more than 2 percent GDP growth.

That is coming in no small part because of what is developing in housing. The biggest risk to this modestly optimistic scenario is whether or not we get agreement on an austerity regime. Or the lack of an agreement forces through a more draconian austerity that we have been referring to as the fiscal cliff.

Duran: What do you see happening in regard to the fiscal cliff?

Goldstein: There is more agreement about what to do on the spending side than what to do on the revenue side. The argument on revenue is largely centered, for political reasons, to increase marginal tax rates.

One strong possibility is that we will go over the fiscal cliff on December 31, which means all of the tax rates automatically go up.

And the new U.S. Congress as its first order of business in the first two weeks of January votes to lower those tax rates for all but the top earners. This allows the politicians to say they voted to reduce taxes as opposed to forcing them to vote to raise taxes.

So that is one compromise, if you like, on the revenue side.

Another possibility, and it isn’t either/or, and we might do a combination of this, is to simply kick the can down the road. And the argument then is whether we come back and go through this all over again in three months, six months or a longer period of time.

It is much less likely, but not improbable, that there will be agreement on a compromise and a more modest fiscal cliff develops on December 31.

In all of this, some things will go into effect early in 2013, especially on the revenue side; further down the road on the spending side.

What appears to be the case is that some degree of austerity will be introduced in 2013, very likely in the first half of 2013. Again, this will take place in an economy that is growing less than 2 percent.

The fundamental condition of the U.S. economy, the lack of demand from consumers, from business, and from exports, is the biggest problem the U.S. economy is facing and has been facing. What may change in 2013 is an increase in housing.

So whatever degree of austerity that we introduce in 2013 means we are further reducing demand. The questions are how severe, and over what time frame? There will be different ways that will be introduced in 2013.

There is no question some things are going to happen in the first half of 2013, and they are all going to effectively reduce demand even further.

Ken Goldstein is an economist with The Conference Board, and can be reached by emailing ken.goldstein@conference-board.org, or calling +1 (212) 339 0331. The Conference Board, www.conference-board.org, is a global, independent business membership and research association working in the public interest.

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About the author: Rachel Duran

Rachel Duran is the editor in chief for Global Corporate Xpansion. Contact her at rduran@latitude3.com.

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