Monday, June 4, 2012


Justin Wolfers tweets a summary of an interesting Greg Ip post:
1) 80% odds China avoids a hard landing 2) 60% chance of Euro-zone solution 3) 70% likely US avoids fiscal cliff =>*Nothing* goes wrong =33%
I can't really comment on China or Europe, both of which are an intersection of politics (which I don't really know enough about to want say much) and economics (which I really don't know enough  about to say much).

But I'd say the US estimate, which is purely about politics, is too pessimistic.

First of all, we're really talking about three or four separate, although possibly interrelated, dangers: the Bush-era tax rates are suddenly removed, yielding a substantial sudden tax increase; the sequester created by the debt limit agreement is implemented automatically because nothing is passed to avoid it; the government defaults thanks to inaction on the need to raise the debt limit again; and then there's a series of other smaller problems and dangers, such as the Doc Fix, and the need to pass FY '13 appropriations, etc. It's possible that the lame duck Congress could avoid some of these, all of these, or none of them; we've seen some scare estimates of the effects of it going wrong, but those estimates could be way too low (if all go wrong) or too high (if few do). Got all that?

So. I think that a landslide either way probably means that none of the disasters happen, for reasons that Ezra Klein talked about today. That includes even a narrow Mitt Romney win that brings with it the Senate, which may or may not happen.

But even if there's a deadlock -- most likely, Barack Obama wins while Republicans hold the House, regardless of what happens in the Senate -- I think it's still better than 50/50 that they'll find some way to kick the can down the road at least, and come up with a medium-term solution at best.

Why? With a re-elected Obama (so they don't have to worry about him running again) and divided government (so they don't have to worry about major Democratic legislation passing) the Republican incentive to destroy the president goes way down. Granted: they tried to do it anyway in 1998! But even that might work in Obama's favor; while the example of rejectionism in 1993-1994 was looked at as a good example for Republicans in 2009, my sense is that few Republicans see 1997-1999 as something to emulate.

Meanwhile, unlike the debt limit debacle from last summer, both parties really do have substantive reasons to compromise this time. After all, Republican-aligned groups and individuals really don't want tax rates to go up dramatically, and don't want significant military cuts. So while I'm sure there are some nihilists in the House who would be happy to risk economic calamity for long-term policy gains (as they see it), it's a whole different story to ask supporters to take short term specific, tangible losses for those long-term gains, especially since those gains tend to be ideological and fairly nebulous. Meanwhile, whatever policy preferences a re-elected Obama might care about, it's fairly certain he would strongly want to avoid economic calamity.

Now, just because the players will have incentives to reach a deal surely doesn't mean that they will. But I think we're probably talking about miscalculation, not deliberate strategy. Moreover, the obvious solutions here involved aren't all that hard to figure out -- what they mainly involve on spending is a deal to substitute pretend (or future) cuts for the sequester, while on taxes the odds are that divided government yields either a replay of the 2010 straight extension, or perhaps a bit of a nudge one way or another in favor of the side that looks strongest coming out of the elections (and with Obama "winning" an extension on the debt limit in exchange for keeping the upper-level tax rates in place while the economy still stinks).

Overall, I'll be surprised if there's a real fiscal disaster in the works this winter. A minor negative, sure, but disaster? There's a real chance, but I think it's below 20%, maybe a fair amount below.


  1. Looking at the original computation of odds, that just doesn't seem valid in a closely interlinked global economy. They are not independent variables; success/failure with any of them increases the prospects of success/failure with the others.

  2. You need to throw in "Israel or the US bombs Iran, leading to massive oil price increases and global economic meltdown" somewhere in there.


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