Is policy uncertainty, such as that surrounding the fiscal cliff, already hurting the economy?
The dysfunction in Washington and lack of clarity around tax law, spending cuts and long-term debt reduction has often been implicated as a factor behind the tepid nature of the economic recovery and the lack of stronger business investment. Policy uncertainty, while lower than it had been during the debt-ceiling standoff of 2011, has been climbing in recent months as we approach the fiscal cliff, according to the Economic Policy Uncertainty Index developed by a trio of Stanford and University of Chicago economists.
Yet in an analysis published Friday, Goldman Sachs economists Jan Hatzius and Sven Jari Stehn argue that such uncertainty – high though it may be – is not the driving force behind U.S. economic weakness. And they try to turn the traditional argument on its head, suggesting that the reduced economic activity, and the crisis in Europe, has led to the increased policy uncertainty.
“We do not doubt that uncertainty shocks depress economic activity, or that uncertainty has risen substantially since 2006,” they write. “But we do not believe that the economy’s poor performance has been caused by an exogenous increase in U.S. policy uncertainty.”
The Goldman economists argue that the continued economic sluggishness we’ve experienced since the official end of the Great Recession in June 2009 is in keeping with past history. They cite the work of Carmen Reinhart and Kenneth Rogoff – as well as research into past credit booms and busts by economists Moritz Schularick and Alan Taylor – in concluding that the U.S. economy has performed “no worse” than history would suggest, and maybe even a bit better. “The U.S. economy has performed in line with (or slightly better than) the historical average of financial recessions following a big debt buildup,” they write.
But, the Goldman economists say, if uncertainty hasn’t been a major cause of our recent economic weakness, it could be a serious danger going forward: “As the U.S. economy approaches the fiscal cliff at yearend, there is now a compelling and largely exogenous reason to expect an increase in policy uncertainty, which could deal a nasty blow to economic activity.”
The Goldman team concludes that the cliff poses further risks to an economy that they already expect to slow next year. “Ultimately,” they write, “we view policy uncertainty as one more reason to worry that the better recent U.S. economic growth pace may not be sustained.”
The economic shock may already have started, they suggest, as capital spending has declined over the past few months – though consumer confidence has climbed recently and other economic data has come in stronger than expected, casting doubt on the effects of the cliff too. “The jury on whether we are already seeing a policy uncertainty shock unfold is therefore still out.”
If the economists are unsure whether the fiscal cliff is already having an effect, they might want to check with Goldman Sachs CEO Lloyd Blankfein. In a recent interview with CNBC, Blankfein was asked if the cliff is affecting the economy right now.
“Oh, absolutely,” he said. “The fiscal cliff specifically is one of the major ways in which the slow recovery that we have could be completely derailed. Hard landing in China. Euro collapsing. Problems in the Middle East. And fiscal cliff is probably paramount in that area. We just met with a dozen of the largest high-tech company CEOs in the country. Not only are they hoarding cash – all their customers, all their suppliers are. They're scared to death we're going to go over this cliff and it could be a catastrophe.”
Josh Boak contributed to this article.
