The 2012 US presidential election is perhaps one of the most unique and important elections in recent history from an economic perspective (with the time-line rapidly approaching). In choosing its leader for the next four years (for which we provide a handy ‘where-do-they-stand’ cheatsheet), we agree with Goldman that the country will likely be determining the path for near-term economic growth, medium-to-longer term fiscal stability and monetary policy at a time when the stakes are exceptionally high – whether or not the US economy returns to recessionary conditions in 2013, the US sovereign debt rating and the broader credibility of the US government to Americans and foreigners alike all hang in the balance. Goldman sees three factors that set the 2012 election apart.
Via Alec Phillips, US Political Economist at Goldman Sachs:
Legislative inaction now a greater risk than legislative action
The potential for legislative inaction may pose a greater risk and more uncertainty than legislative action, suggesting that the one almost foregone outcome of the current election – divided government – poses greater challenges than in the past. Typically, divided government is viewed as a constructive political outcome by markets as it (normally) reduces the likelihood of major policy change and hence policy uncertainty.
But in the current environment the opposite may be true, as Congress must take action (by year-end in many instances) to avoid large (and mostly undesired) shifts in policy. This is because policy has become more temporary, mainly owing to the congressional budget process, which measures the cost of legislation over ten years and thus makes temporary legislation appear less expensive than longer-lasting policies.
The glaring risk in front of Congress is the “fiscal cliff” – roughly 3.5% of GDP in tax increases and spending cuts set to occur at year-end. This makes the 2012 election one of only a few contests in which such a large fiscal policy shift was on the table so soon after the election took place (2008 is arguably another example, when the election represented, in part, a referendum on the size and composition of a stimulus package expected to be passed early in the following year). Our base case is that Congress will just barely reach an agreement before the end of the year, averting most of this fiscal restraint, but it is quite possible that Congress could fail to address the issue by that deadline, leading to a substantial fiscal drag on growth, at least temporarily.
A status quo political outcome raises the risk of a game of fiscal “chicken” at year end, in which policy goes “off the cliff” unless one party reverses their long-held position on the upper income portion of the 2001/2003 tax cut (luckily for the US economy—and unlike the real game of “chicken”—a retroactive extension is possible in early 2013). A Romney win seems more likely to lead to a short-term extension of the 2001/2003 tax cuts and some aspects of the fiscal cliff. In either scenario, it is imperative that Congress act, which is a unique and important difference from typical elections, with the economic consequences of them failing to do so potentially recessionary.
The fiscal stakes are higher than they have been in decades
Beyond the fiscal cliff, the winner in November will face a potentially frustrating fiscal landscape: on one hand, the elevated level of debt—around 75% of GDP and rising—limits the fiscal room to maneuver. On the other hand, the Treasury’s exceptionally cheap interest expense—around 1.4% of GDP, less than half the level that prompted deficit reduction efforts in the late 1980s and 1990s—has dulled the pressure on lawmakers to tackle these issues. This should be a recipe for inaction. But two issues will likely raise the stakes in reaching a longer-term fiscal agreement early on in the next administration:
(1) the need to once again increase the debt ceiling which congressional Republicans would like to match with deficit reduction (over ten years) of an equal amount, and
(2) the renewed threat of a sovereign downgrade by the ratings agencies, who have signaled as much if the US doesn’t stabilize its debt ratio by mid-decade.
A deficit reduction agreement of $2 trillion over ten years could resolve both issues, but with the easy cuts already made in last year’s debt limit agreement, only the most difficult aspects of a fiscal “grand bargain” remain.
Monetary policy in (political) focus
Elected officials have hardly been indifferent to monetary policy in the past, but there have been few elections where Fed policy was as widely debated as it is today. Compounding this is the expiration of Chairman Bernanke’s term in January 2014; Romney has already indicated that he will not nominate Chairman Bernanke for another term. While Romney is not alone in making his intentions to replace the chairman clear, what makes this situation unique is that it comes at a time when the Fed is pursuing unconventional policy that depends much more than usual on a forward commitment that occurs mostly past the end of the current Chairman’s tenure.
Any of these issues would make the upcoming election an important one for the economic outlook, but the combination of a near-term risk in the fiscal cliff, increasingly problematic medium-term fiscal dynamics, and election-driven uncertainty on monetary policy at a time when the credibility of future commitments is necessary for its success make this a unique election, with potentially substantial and far-reaching economic impacts.