Tue, 11 Dec 2012
Any deal to avert the fiscal cliff will modestly hit the economy, but legislators won't allow the worst-case scenario--and subsequent recession--to happen, says Northern Trust chief economist Carl Tannenbaum.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Carl Tannenbaum. He's the chief economist at Northern Trust. We're going to look at the fiscal cliff and what impact it could have on the economy. Carl, thanks so much for joining me today.
Carl Tannenbaum: It's great to be here.
Glaser: Let's go ahead and start with the fiscal cliff. There's been a lot of political posturing on both sides of the aisle about the best way to kind of reduce these increases in taxes and then the cuts in spending. Do you think this actually is just posturing, or is there really a potential that we are going to fall over the entire cliff?
Tannenbaum: I would caution against getting overly alarmed by some of the statements that are made in the newspapers. Those are primarily stakeout positions, both for your side and for the other side. In situations like this, by far, the more productive conversations are happening behind closed doors, which is frankly where I think they belong.
Glaser: What are your expectations for what a final deal will look like?
Tannenbaum: Given the stakes involved with going over the cliff, I would find it very unusual if that were the outcome. The degree of discussion that we've had since the election has clearly exceeded what we had in the six months prior, and I think both sides want to avoid that worst-case outcome. We think that they will come to a resolution that will be pleasing to the markets. They probably won't tackle the broad issues of tax reform and entitlement reform, but they'll do enough to get the worst case off the table.
Glaser: If we have this kind of two-step solution where we handle some of the short-term issues and maybe tackle those other issues later, what does that mean for the economy, and what does it mean for growth?
Tannenbaum: We are looking at a drop from a growth rate of about 2% to a recession of 2% if we go over the cliff, and that may understate things, because it doesn't include some of the psychological things that will follow from going off the cliff, such as rating agency corrections. In addition, I would suspect that many consumers don't know just how bad their pocketbooks are going to be hit if we go off the cliff. So, that will certainly give us a trajectory of growth starting in 2013 that will be much better than the worst-case outcome.
Glaser: As we look at that in respect to consumers, let's say, you mentioned that it could hurt the pocketbook. If the deal does raise taxes on some consumers, is that going to really pinch consumer spending, or are consumers still going to be able to open their pocketbooks?
Tannenbaum: Listen, there is not going to be any formulation for dealing with the cliff that isn't going to involve higher taxes for at least some taxpayers and some cuts in spending on the other side. So, the economy is going to take a modest correction as a result of any compromise that's reached. Hopefully the design of those things, though, will be minimally invasive and affect those taxpayers who perhaps can best endure higher levels of taxation and pick spending areas that will be less damaging to overall economic growth.
Glaser: How about the employment picture? Certainly this has been a big focus of a lot of market watchers. The report this month looked a little bit better than expected. Do you think the fiscal cliff is going to have a big impact on jobs or the potential solution will have a big impact to jobs? Or are we going to continue on this kind of slow-growth trajectory there?
Tannenbaum: I think the fiscal cliff has had a big impact on both the employment picture and also on capital spending. The uncertainty around tax rates has paralyzed many businesses as they think about making those big-picture investments in both equipment and new employees. In addition, the labor market elements are tortured by the fact that health care is caught up in some of the budget discussions now under way, and so, this trajectory of employment creation which has very much been substandard relative to past expansions is perhaps partly attributable to the cliff. If we can clear some of those elements, I'm very hopeful that the trajectory of job creation will get much better next year.
Glaser: What about housing? Certainly, that's been a big hope of the recovery that housing would help really build up employment, build up gross domestic product. Is that something that you think is still in the cards or is potentially in the cards?
Tannenbaum: Well, housing has done very well so far this year but is still a long way from what it had been. It faces a lot of limitations, among them there a lot of new rules that still have to be written about housing and mortgages. But when it comes to the cliff, there are a couple of elements that are harmful to housing. One is the confidence issue. People don't know what tax rates are going to be. Don't know how the economy's going to perform, and therefore are a little bit more hesitant about buying homes. And then very directly, since home mortgage interest is among the deductions that might get curtailed under some formulations for dealing with the cliff, the property markets in certain states might be hindered by that kind of compromise.
Glaser: Looking a little bit abroad to Europe just for a moment, certainly as we have in our discussion about the fiscal cliff, the eurozone crisis remains grim in still trying to come up with ways to deal with the sovereign debt problems in Greece and Spain and elsewhere. Do you think those problems represent a big threat to the United States? Is it something investors should still be worried about, or has that calmed down enough that they can focus more on those domestic fiscal issues?
Tannenbaum: Well, for Americans who are frustrated by what's going on in Washington, they only have to look to the other side of the Atlantic Ocean to feel comforted, where the level of dysfunction is many times what we have in Washington. Europe is going into recession. They have banking problems, and trying to get a policy consensus amongst the 10 members of the eurozone or the 27 members of the European Union is a very difficult thing to do. This does have a very big impact on the United States. Our multinationals that sell over there are already seeing a hindrance to their revenues and their profits, and in addition, if the worst-case outcome occurs, such as Greece fails or you have a bank failure, the connection between those aspects and U.S. financial systems and financial institutions could create contagion that would be very damaging.
Glaser: Given the headwinds potentially with the fiscal cliff and Europe. What's your expectation for GDP in 2013 and beyond?
Tannenbaum: We've got a forecast out there for 2013 that shows real economic growth in United States of 1.8%. Clearly the downside risk would be a bad outcome in Europe or a bad outcome from the cliff, but I don't want to rule out the possibility that we could do a little bit better if those uncertainties are cleared. There's a lot of pent-up demand. We have been expanding slowly for a while, and there is an additional gear that I certainly hope that we'll reach someday soon.
Glaser: Well Carl, I really appreciate you taking the time to talk with me today.
Tannenbaum: Great to be with you.
Glaser: For Morningstar, I'm Jeremy Glaser.