The fiscal cliff “catch-22”

The excerpt below from Joseph Heller’s 1961 fictional novel explains that “Catch-22” is a military rule that sets up the necessary pre-requisite to avoid flying combat missions:  

"There was only one catch and that was Catch-22, which specified that a concern for one's safety in the face of dangers that were real and immediate was the process of a rational mind. Orr was crazy and could be grounded. All he had to do was ask; and as soon as he did, he would no longer be crazy and would have to fly more missions. Orr would be crazy to fly more missions and sane if he didn't, but if he were sane he had to fly them. If he flew them he was crazy and didn't have to; but if he didn't want to he was sane and had to."

The “fiscal cliff” issues that Congress may or may not deal with in the coming weeks are not much different than the situation “Orr” was faced with in Heller’s novel.  The following excerpt from the Congressional Budget Office (CBO) report — “Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013 explains the “Catch-22” dilemma facing Congress:

Growing debt would increase the likelihood of a sudden fiscal crisis, during which investors would lose confidence in the government’s ability to manage its budget and the government would thereby lose its ability to borrow at affordable rates. Such a crisis would confront policymakers with extremely difficult choices. Again, the current high level of debt relative to the size of the economy means that further substantial increases in debt would be especially risky in this regard.

Therefore, eliminating or reducing the fiscal restraint scheduled to occur next year without imposing comparable restraint in future years would have substantial economic costs over the longer run. However, as shown earlier in this report, allowing the full measure of fiscal restraint now embodied in current law to take effect next year would have substantial economic costs in the short run.

The CBO report is every bit as circular in its application of logic as Heller’s “Catch-22.” The report seems to be recommending a “kick the can down the road” approach to the pending fiscal cliff as an alternative to simply jumping off the cliff. The implication is that perhaps we should delay the proposed austerity measures currently scheduled and designed to bring deficit spending under control for one more year while at the same time explaining that in so doing we are assuming substantial risk of impeding our ability to borrow at affordable rates. 

In other words, we should avoid the fiscal cliff for a little longer. If we follow this course, we avoid the recession resulting from the fiscal restraint initiatives but end up in recession because fiscal irresponsibility. If we go ahead with the planned tax hikes and spending cuts, we go into recession because of these austerity measures. In either case we end up in recession just as Orr ends up flying combat missions.   

There are a several major players attempting to coerce Congress into the “don’t jump” camp. Specifically, Federal Reserve Chairman Ben Bernanke — who coined the term fiscal cliff — has moved away from his often repeated position that fiscal matters are not within his purview. Bernanke has chosen to meet with legislators to weigh in on the pending tax hikes and spending cuts.  Even Wall Street CEO’s are heading to Capitol Hill to offer their advice on how to deal with the fiscal cliff issues. 

Despite arguments to the contrary coming from the “don’t jump” proponents, there is a huge risk associated with delaying the scheduled austerity measures and the CBO is not understating the nature of that risk. On the other hand, if we “do jump,” recession is the likely outcome. To suggest that we should avoid the fiscal cliff seems every bit as irresponsible as suggesting that we should move forward with the tax hikes and spending cuts and just jump off the cliff.

There are many — probably most — who simply refuse to admit that no palatable solution exists to the fiscal cliff issue. The assumption is that we can deal with the debt and deficit when the economy is on stronger footing. That same logic has been applied for four years now as monetary and fiscal stimulus has been injected into the economy at unprecedented levels and to no avail.

GDP growth has proven to be a particularly stubborn problem, having fallen in the first quarter of 2012 and again in the second quarter of 2012. The most recent data showing third quarter results reflects a modest improvement in the rate of GDP growth but on close examination, a substantial portion of GDP for the third quarter was the result of increased government spending in that quarter. The second quarter GDP was a mere 1.25% and the GDP growth rate trajectory has been lower through most of 2012.  Likewise, unemployment has resisted all attempts to rejuvenate the economy through stimulus efforts. The U6 unemployment number continues to hover around 15%.   

We have reached a point where the fiscal stimulus intended to solve the problem of slow GDP growth and high unemployment can no longer be viewed as a solution. The truth is these stimulus measures — resulting in unsustainable debt and deficits — must now be viewed as part of the problem itself. 

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