FT Alphaville " Preemptive fiscal folly It's really hard to predict the eventual outcome of the fiscal cliff negotiations that will take place after the elections, but the media reports that there is little enthusiasm for extending the payroll tax cut (in place since January 2011) are starting to pile up. Annie Lowrey in this morning's NYT: Its expiration means less income in families" pocketbooks - the tax increase would be about $95 billion in 2013 alone - at a time when the economy is little better than it was when the White House reached a deal on the tax break last year. Independent analysts say that the expiration of the tax cut could shave as much as a percentage point off economic output in 2013, and cost the economy as many as one million jobs. That is because the typical American family had $1,000 in additional income from the lower tax. As Matt Yglesias notes, this is an awfully strange idea for Republicans and Democrats to agree on before negotiations have even begun. It would function as the equivalent of a regressive tax hike, a threat to immediately curb consumer spending while the recovery is still sluggish. Meanwhile, a constantly under-appreciated but related trend is that fiscal drag has already been happening for a while and would continue even if the entire fiscal cliff were to be avoided. From the latest monthly outlook by Credit Suisse economists: While federal expenditures are historically elevated as a share of GDP, the level is falling in sequential terms with the expiration of past stimulus measures and the winding down of two wars. Real federal spending in national income terms has declined in six of the last seven quarters. "Austerity" is nothing new at the state and local government levels, with real spending down in nine consecutive quarters (and with no recovery in prospect). And a chart from Goldman equity strategists (you're looking at the dark blue shading, and click to enlarge): Interest rates remain low and the Fed is now committed to keeping them low even if the recovery accelerates, at least initially. And at the end of this year, there's a chance the Fed will again continue buying longer-term Treasuries even after the expiration of Operation Twist to avoid the appearance of a passive tightening so soon after the bold announcements from its latest meeting, and to keep supporting the nascent housing recovery. Bernanke certainly wouldn't phrase it this way and perhaps we're oversimplifying things, but fiscal policymakers and the Treasury right now have a kind of green light from the Fed to issue more debt and do what's needed to at least prevent the fiscal drag from becoming too extreme. Yes, this might smack of implicit cooperation between the Fed and fiscal authorities - but implicit cooperation now is better than needing explicit cooperation later. This is all before getting into the tangled issue of the collateral grab and safe asset shortage, about which we've spilled enough pixels. We're trying to be open-minded and could well be wrong, but once again it's hard to avoid the conclusion that the fiscal policy debate now shouldn't be about whether the government should borrow more in the short term to support the economy, but about how best to do so. Yet that isn't what's happening, not even close. Related links: Five questions about the Federal Reserve and monetary policy - Ben Bernanke Why I agonize about the zero bound - Tim Duy This entry was posted by Cardiff Garcia on Monday, October 1st, 2012 at 18:09 and is filed under Capital markets. Tagged with fiscal cliff.