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What Bernanke Really Meant by ‘Fiscal Cliff’

Alan Greenspan would have been proud of the Ben Bernanke-coined “fiscal cliff.”

That’s exactly the kind of phrase Greenspan would have used when he was chairman of the Federal Reserve — an expression with no pre-existing meaning that makes immediate headlines but doesn’t say anything specific.

That was how Greenspan used to go on record without creating a political headache for himself or for the Fed because, once uttered, the phrase meant different things to different people

Just think about “irrational exuberance,” one of the most infamous of all the Greenspan-created phrases. Greenspan used the phrase to say that investors weren’t reading the tea leaves correctly, that an asset bubble existed, that a big drop in prices was ahead and that a lot of people were going to lose a great deal of money. Saying that directly would have tanked the markets and subjected the chairman and the Fed to serious criticism from Members of Congress and Wall Street. Using the new phrase later allowed Greenspan to say, “I told you so” without actually ever having specified what it was he was telling us about.

This is the reason “fiscal cliff” has been so effective since Bernanke first used it at a hearing of the House Financial Services Committee in February.

It clearly is a warning, but it’s not at all immediately clear what needs to be done to mitigate the impending disaster. Since it was first invoked, fiscal cliff has been used both by those who insist the budget deficit has to be reduced and all of the spending cuts and revenue increases scheduled to go into effect from Dec. 31 to Jan. 2 should be left alone, and also by those who say that now is not the right time to reduce the deficit by that much that fast.

For the record, although the explanation wasn’t reported or repeated as much as the catchphrase itself, Bernanke actually said the fiscal cliff was about the large spending cuts and tax increases already scheduled to occur being far too big for the current U.S. economy to handle at one time. “I hope that Congress will look at [the spending cuts and revenue increases] and figure out ways to achieve the same long-run fiscal improvement without having it all happen at one date,” he told the committee.

In other words, “fiscal cliff” means the big deficit reductions that have been both inadvertently and intentionally scheduled to go into effect at the turn of the year are the absolutely wrong fiscal policy at that time and that the economy will be damaged if they are not changed.

Bernanke was also saying something that he could not say directly: Next year’s federal budget deficit needs to be substantially higher than what it will be if current law isn’t changed.

This was a Houdini-like escape act. Regardless of whether they make economic and budget sense, reducing the deficit, cutting spending and not raising taxes are politically very popular positions for most Members of Congress, and Bernanke saying no to any of them directly would have brought hell and damnation down on the Fed and its chairman at a time when they already were under a great deal of political pressure from Republicans on Capitol Hill not to get involved in fiscal policy.

Using a Greenspan-like phrase to say these things obliquely meant that Bernanke and the Fed haven’t been in the line of fire when, as happened last week, the true economic damage the fiscal cliff will cause broke out in the public for all to see.

It’s not that there weren’t previous estimates from Wall Street and elsewhere of how much the fiscal cliff would slow economic growth. But it took an extraordinarily un-Greenspan-like (that is, direct and easy to understand) report by the Congressional Budget Office to focus attention on what will happen.

The CBO, which publishes some of the most useful but also least appreciated budget analysis in Washington, said on May 22 that the fiscal cliff will reduce real gross domestic product by 4 percent from fiscal 2012 to 2013 with the economy contracting at an annual rate of 1.3 percent in the first half of the year. The CBO then used a word seldom seen in published federal documents: The two consecutive negative quarters, it said, means the U.S. economy will be back in a “recession.”

The CBO also said stopping the fiscal cliff policies from going into effect means that real GDP will grow in calendar year 2013 by around 4.4 percent, well above the 0.5 percent it projects will happen if there are no changes.

What was Bernanke really saying when he talked about the fiscal cliff? Go back to his statement above and it’s actually not hard to see that his recommendation is that the deficit be reduced by as much as is scheduled to happen during the fiscal cliff but to do so over a much longer period (“the same long-run fiscal improvement”). That will leave the budget deficit much higher than it otherwise would be every year, but it will keep the economy moving forward instead of declining.

No doubt Greenspan will be at least as proud of Bernanke if that happens as he likely was when fiscal cliff was introduced to the political world.

Stan Collender is a partner at Qorvis Communications and founder of the blog Capital Gains and Games. He is also the author of “The Guide to the Federal Budget.”

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