US economic forecast beyond fiscal cliff fears


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Transcription of Finance News Network Interview with Professor Geoffrey Garrett, Dean of the University of Sydney Business School and Professor of Politics at the US Studies Centre
Lelde Smits: Hello I’m Lelde Smits for the Finance News Network and joining me is Professor Geoffrey Garrett, Dean of the University of Sydney Business School and Professor of Politics at the US Studies Centre. Geoffrey, welcome to FNN.
Geoffrey Garrett: My pleasure.
Lelde Smits: No sooner had US President Barack Obama been elected than attention swiftly turned to America’s looming fiscal cliff. Geoffrey could you explain, simply, what is the fiscal cliff?
Geoffrey Garrett: The witching hour is midnight on New Years Eve of this year. Unless Congress and the President do something there will be about 2.5 points shaved out of the US GDP [Gross Domestic Product] with a combination of mandatory spending cuts and the ending of tax cuts: Two kinds of tax cuts, the Bush tax cuts for all Americans and the Obama tax cuts on payroll taxes.
Lelde Smits: When and why were these original tax breaks and spending measures implemented?
Geoffrey Garrett: The Bush tax cuts were of course post 9-11, so it’s 10 years ago when the US economy was in a pretty deep funk, not as deep as it is today. And, George Bush decided that tax cuts were really important to jump starting the US economy. The Obama tax cuts, the payroll tax cuts, were post global financial crisis in 2009. And, on the spending side this is so called sequestration, automatic spending cuts, and those were mandated about 16 months ago when the US reached its debt ceiling. And, this was this deal that allowed the US to expand its debt ceiling.   
Lelde Smits: If the US Government fails to take action before the end of this year what will happen if the government falls off the fiscal cliff?
Geoffrey Garrett: If the US falls off the fiscal cliff it will go immediately into recession, that’s what the independent congressional budget office said last week. And, it will probably drag the world economy into recession too. So, you’d think that that is suicide. Of course people are worried that American politics is so partisan that suicide is possible.
Lelde Smits: What action does the US government have to take in order to avoid these negative implications and what are the options?
Geoffrey Garrett: It’s before Christmas, so long before President Obama is re-inaugurated next January, the big decision has to be taken. So, it’s got to be a deal in the US Congress between the Democratic senate and the Republican house that Obama can sign. The big issue I think is what to do with taxes for wealthy Americans, people earning more than $250,000. And, I think the path of least resistance is to keep the Bush tax cuts for high income earners as long as they qualify as being small business owners.  
Lelde Smits: What do you believe is the likelihood of the government successfully negotiating and passing through the necessary changes to avert a recession?
Geoffrey Garrett: I think a deal will be done. It will probably be done in the shadow of Christmas, not much before. And, it will have two features. There will be an extension of the Bush tax cuts, with this proviso that high income tax cuts are dependent on someone qualifying as being a small business owner. And, on the other side what they will do with spending is they’ll make lofty long-term spending cut projections, but reduce the spending cuts in the short term.
The world will see that as yet another bandaid with the US not being willing to address its big fiscal problems. But, I think the implicit strategy actually is that the US doesn’t want to cut its way out of deficit it wants to grow its way out of debt and deficit. 
Lelde Smits: Most commentators including yourself appear confident the US will do a deal and pass through the necessary means to conquer the fiscal cliff. But Geoffrey, if there is such confidence why is there still so much concern?
Geoffrey Garrett: The reason is that the Republican party I think has imploded after Mitt Romney’s loss in the Presidential election. So, the Republican’s don’t know whether they should run to the left of to the right. Or in fact to the centre or to the right. And you’ll remember from two years ago, there’s now this group of Tea Party Republicans who are just allergic to government and in particular allergic to taxes. And, they now have a champion that champion is Paul Ryan who is Mitt Romney’s Vice Presidential running mate. So, there is a sort of red meat Republican movement that says, “Say no to any, any tax increases”.
Lelde Smits: Beyond the fiscal cliff deadline and into next year, what developments do you foresee will mark America’s debt situation?
Geoffrey Garrett: What I expect going forward is actually not a grand bargain to do something massive on fiscal policy – either on taxes or spending – But rather, a continuation of what we’re currently doing, which Americans call, ‘kick the can down the road’. And, you can kick the can down the road if you think you can grow ultimately out of debt and deficit and I think the US actually isn’t in a bad place to do that.
The US Government can borrow money at negative real interest rates, nominal rates of about 1.7 per cent. The US is one of the youngest countries in the OECD [Organisation for Economic Co-operation and Development] so it doesn’t have a big demographic problem. It remains the world’s innovation engine and as a result it’s the world’s innovation magnet. So, the fundamentals in the US economy I think we tend to overlook the fact that the fundamentals in the US economy are still really strong. Sure, the last four years have been horrific but the fundamentals are still there.
Lelde Smits: But in the short term Geoffrey the US government is grappling with debts of more than $16 trillion. Do you really believe they can move into surplus?
Geoffrey Garrett: Yes, and we have history for this. Ronald Regan ran up a massive deficit in the 1980s in the United States. By the end of the Clinton presidency at the 1990s the US was back in surplus. That didn’t happen through a lot of tax increases and spending cuts. That happened because US growth in the 1990s was so strong. Now, can the 2010s be the 1990s again? Unlikely, not impossible. But I think that that is going to be the trajectory. We’re not going to see European style austerity in the US. What we’re going to see is bandaid deals with this hope US growth will come back. And, I think it’s also important to remember that the US probably only needs to grow at about 3.25 to 3.5 per cent per year in GDP growth for that to be realistic.
Lelde Smits: Professor Garrett, thank you so much for your insights today.
Geoffrey Garrett: My pleasure.