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Cliff Deal May Not Cut the Deficit

By Suzy Khimm, WonkBlog - December 31, 2012

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There are two facts you should know about the “fiscal cliff” deal: 

Deficit hawks aren’t likely to be pleased with the fiscal cliff deal. (Source: Washington Post/James F. Lee)

One, it won’t reduce the deficit by much. 

Two, it won’t avert the fiscal cliff.

Whatever deal gets worked out this week will be very narrow in scope, simply delaying major parts of the fiscal cliff and doing little to reduce the deficit. You could have predicted this would happen from the moment that the “grand bargain” negotiations between President Obama and House Speaker John Boehner broke down: Since then, the big, numerical targets for deficit reduction have disappeared from the public debate, which has shifted to focusing almost exclusively on the individual components of a small, short-term fix in the name of averting an immediate austerity crisis.

The short-term deal addresses just the tax components of the cliff, and the concern about raising revenue for long-term deficit reduction has been sidelined by the growing urgency for a short-term patch, the Republican desire to keep the Bush tax cuts (many or most of which will be extended) , and the Democratic commitment to including some stimulus in the deal (the $30 billion extension of unemployment insurance that will likely be in it). The sequester would simply be delayed for a few months. And there will be little if any deficit reduction in the package.

That deal will blunt the free fall scheduled to begin taking effect after midnight tonight, providing some measure of relief to anxious businesses, consumers, and investors who’ve been worried about the effect of fiscal contraction on immediate growth. But it will also be a huge disappointment to deficit hawks who have been pressuring legislators to prioritize deficit reduction above all else, using the fiscal cliff as a forcing mechanism for much larger reforms. “I’ve never looked at the fiscal cliff as being our purpose. Our purpose is much larger comprehensive agreement,” former Sen. Judd Gregg, who’s part of the Fix the Debt campaign, told me a few weeks ago.

Deficit hawks have been predicting that such a fix"””kicking the can,” in their parlance"”will have terrible consequences for the U.S.: Ratings agencies have already threatened to downgrade the U.S. again if it fails to contain its long-term deficit, making it more likely that the bond vigilantes will return, interest rates and borrowing costs will rise, and long-term investment and economic growth will be depressed.

But for right now at least, the investors in U.S. debt don’t seem terribly concerned about whether or not there’s major austerity in a fiscal cliff deal. Rather, like most others, they’re worried about whether we’ll go off the cliff and let too much austerity happen all at once. The price of U.S. debt"”including 30-year Treasuries"”has fluctuated on the likelihood of a deal, with bond prices rising (and yields falling) as negotiations have broken down.

After Harry Reid hinted on Thursday that we might go over the cliff, ”that seemed to be the catalyst for the rise in bond prices,” David Keeble, global head of interest rates strategy at Credit Agricole Corporate & Investment Bank, told Bloomberg. Treasuries have seen fallen as the prospect of a deal has looked more likely, and interest rates are likely to close out the year at record lows"”even though the long-term deficit will barely be reduced, if at all. “The yield could set the lowest year-end closing level on record, as the current level trades below 1.88% at the end of 2011,” the Wall Street Journal explains today.

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