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Fiscal Cliffhanging Causes National Nervous Breakdown

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Many economists are warning about the possible psychological scars left by the cliff, not the relatively straightforward cash flow issues that Democrats and Republicans must reconcile before the start of next year.

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"What's to me much more worrisome is the psychological effects of falling off of the cliff in a number of respects," Krueger told the Economic Club of Washington. "It would mean to many people that the government is not there to solve the problems it was meant to solve."

The challenge is that these psychological responses approach the limits of data-driven economics. Consumer confidence is at a five-year high of 82.7 according to a University of Michigan index, despite all the understandable carping about uncertainty.

Swarthmore College professor Barry Schwartz recently proposed that Obama create his own "Council of Psychological Advisers." This group of PhDs would complement the existing council of economists led by Krueger, helping the president to think through how government policies impact behavior.

"The recent financial crisis and its persistent aftermath make it clear that ignoring the real psychology of 'irrational' enthusiasm (or pessimism) can be perilous," Schwartz wrote this month in The Atlantic. "This is not to say that macroeconomic variables don't matter and that the behavior of the economy is completely driven by the psychology of participants. Of course macroeconomic variables matter. But they are not, and never have been all that matters."

But a major part of the fiscal cliff is, in fact, the result of a psychological trick by policymakers. When the bipartisan super committee was unable to agree on spending reductions last year, they set into motion the budget sequestration that will slash $109 billion for defense and domestic expenditures next year.

Because Congress has a short-term incentive to keep splurging, it created a cliff as a mechanism to curtail the growth of a national debt that now tops $16 trillion. Obama and lawmakers were lashing themselves to the mast just like the mythical character Ulysses did in order to hear the mythical sirens.

"They've basically said, we're going to force ourselves to do the responsible and right thing by setting up a cliff," Shankar Vedantam, author of The Hidden Brain, recently explained on NPR. "And the cliff is so bad, and its consequences are going to be so detrimental, that it's going to force us to get our house in order. So essentially, what the cliff does is it makes the long-term challenge salient in the short-term. It puts a looming catastrophe right in front of us and says, this is going to get everyone's attention to sit down and focus."
But even if the cliff succeeds in imposing discipline, any deal is unlikely to instantly produce much certainty - one of the most important psychological salves that the government could offer.

"Frankly, I think the markets have this wrong," said Greg Valliere, chief political strategist for Potomac Research. "A deal around December 21 probably would be an agreement in principle, with a commitment to fill in the blanks during the first quarter. So there potentially will be another three months of uncertainty in 2013. So the good news may be that we won't plunge over the cliff in early January; the bad news may be still more months without clarity. If you believe, as most economists do, that businesses aren't spending or hiring because of all the uncertainty, this scenario is no prize."

In other words, politicians don't just have the mission of talking the government off the cliff. They also just might need to talk the nation off the ledge.

Editor's Note: This article by Josh Boak originally appeared on The Fiscal Times.

For more from The Fiscal Times:


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How Obama Misplayed the Tax Card against Republicans

As Asian Economies Grow, American Influence Shrinks

Follow The Fiscal Times on Twitter @TheFiscalTimes.
No positions in stocks mentioned.
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