Today’s excitement is that the FOMC minutes talked about the views of the various participants about when asset purchases should come to an end. “Several” members thought it would “probably be appropriate to slow of stop purchases well before the end of 2013”, while “a few” saw purchases running to the end of the year and “a few others” did not see a specific time frame. The FT’s Robin Harding points out that “several” in the Fed minutes means 4-5, while “a few” means 2-3, which suggests that the committee is roughly evenly split, so it is a stretch to interpret the minutes as hawkish. More significantly, as Bernanke explained at his latest press conference, the purpose of asset purchases is to increase the “near-term momentum” of the economy; if “several” members expect near-term momentum to pick up well before the end of 2013 then it would be entirely coherent for them to expect asset purchases to end on the same time frame. If momentum does not pick up, there is no reason to suppose that the “several” members would not support continued purchases.
It is not especially clear how the Fed expected its latest round of asset purchases to work. They are unlikely to have any large effect on interest rates, which the new communication strategy has already brought to extreme lows. Nor are they likely to have much effect through increased inflation expectations, which appear (as proxied by breakevens) to be around a maximum determined by the Fed’s declared tolerance for inflation. Perhaps asset purchases will prevent any deterioration on account of falling inflation expectations — but their stated aim was an improvement, not the prevention of a deterioration. Since it was not clear how asset purchases were supposed to work, it was not clear for how long they would go on. One might think that the latest minutes give some information in this regard. But in fact, since they are consistent with Bernanke’s press-conference comments, I cannot see that they do.
I still do not have a good handle on what happened in the debt ceiling deal, but I can make a few observations. My prediction that the US would go over the cliff was right, but on a much more compressed time-frame than I anticipated. This was partly because House Republicans took the Senate deal to a vote without the support of a “majority of the majority”, something they normally require. I expected the strong opposition of much of the Republican caucus to any kind of tax increase to prevent an immediate deal; implicitly, I expected the President explicitly to emphasise that taxes had gone up automatically on 1 Jan, and to present a new deal as a tax cut, and the Republicans finally to move as the public debate focused on this point. But enough Republicans appear to have anticipated this outcome and to have been prepared to vote immediately. I do not know whether the fact that they were technically voting for a tax cut carried much weight, but I suspect it will have done; I note that Grover Norquist, he of the tax pledge, tweeted that Republicans had not broken their pledges by voting for the deal because of this technical point
I do not have a good model of who won in this situation. Clearly, the Republicans had a very weak hand on the question of tax increases, because of the automatic increases that were already going to take place — and so, clearly, they lost. But did the President win? Assuming that he understands the economic situation and would like to maintain or increase fiscal stimulus, he didn’t win either; the best reading would be that he decided to practise the art of the possible and succeeded in getting some tax increases while avoiding an economically-ruinous fiscal contraction. But I am sceptical about whether he really wanted stimulus. He has described himself as a centrist, and has observed that in the Reagan era he could have been a Republican centrist. Perhaps he believes in the need to cut the deficit today; his public pronouncements certainly suggest that he does. Perhaps, as a politician, he is not thinking in an economic paradigm at all. He has been elected as a Democrat on a platform of higher taxes on the rich, and the political imperative was perhaps to deliver on that — which he has done.
Why was he prepared to put off the questions of the sequester and the debt ceiling for another two months? If there is a strategy here, I have not yet grasped it. Obama has said he will not negotiate on the issue, so perhaps he intends to take it to the wire and appeal directly to the public, or perhaps he will use the platinum-coin option to force the Republicans into a solution that satisfies him.
What of the economic effect of the latest deal? Pragmatic Capitalism estimates, using data from Goldman Sachs, that the tax increases agreed will cost 1.3% of GDP in 2013 compared to the complete aversion of the fiscal cliff, as against 3.5% if the cliff had taken full effect. Brad DeLong estimates 1.75%. Econbrowser estimates that the deal means that GDP will be 0.6-1% (depending on the sequester talks) higher than it would have been if the cliff had taken full effect. It seems that fiscal policy will be a drag on GDP in 2013, in an amount somewhere between 1% and 2% of GDP. The deficit will be reduced; and since the deficit has been the flip-side of the corporate surplus, that surplus may be reduced unless some other factor increases the “total pie” enough to offset this effect.