The US Fiscal Cliff Threatens Global Economy

In 2012 the USA has found itself on a slippery slope towards a fiscal cliff. On the 31st of December 2012 taxes are set to rise, while fiscal stimulus measures will end. The resulting contraction in government spending has the potential to push the US economy into its second recession in four years. In the USA’s heavily polarised political arena there is a real danger that political recalcitrance could force consumer and business confidence on a downward trajectory and threaten global growth.

Annual Real GDP Growth in the USA: 2006-2013


Source: Euromonitor International from national statistics/Eurostat/OECD/UN/International Monetary Fund (IMF), World Economic Outlook (WEO), Congressional Budget Office

Note: (1) CBO Fiscal Extension – Congressional Budget Office estimates where all fiscal policies are extended. (2) CBO Fiscal Cliff – Congressional Budget Office estimates where no fiscal policies are extended. (3) 2012-2013 figures are estimates

  • The main fiscal measures set to expire are the George W. Bush administration tax cuts which reduced income and capital gains tax costing the USA an estimated US$2.8 trillion between 2005 and 2014 if the measures are extended, according to the Center on Budget and Policy Priorities. Obama’s 2009 stimulus measures, a mix of infrastructure spending and tax cuts originally costing US$787 billion aimed at supporting economic growth amid the global economic downturn, are also about to end;
  • November 2012 is the date of the USA’s upcoming presidential elections. The heavily partisan campaign by both the Republican and Democratic camps has focussed on fundamentally different economic views. The outcome of the election will therefore have a pronounced impact on the fiscal cliff debate;
  • The USA’s economic outlook is weakening once again, especially in manufacturing, increasing calls for government action. According to the Institute of Supply Management the Production Index for manufacturing registered a significant decline of 4.6 percentage points from the previous month, dropping to 51.0 for June 2012. Failure to resolve the fiscal cliff in the world’s largest economy also threatens the fragile global economy.


The effect the fiscal cliff will have on the economic performance of the USA is significant. The Congressional Budget Office (CBO) estimates indicate the cliff will reduce the government’s spending by around 4.0% of GDP in the fiscal year of 2012-13, a US$607 billion reduction. In a scenario where the cliff is not avoided the CBO estimates real GDP growth will decline by around 1.3% in the first half of 2013, returning the country to recession.

  • Differences in economic beliefs mean there is little likelihood for a resolution to the fiscal cliff issue before the November 2012 elections. Mitt Romney, the Republican candidate has pledged to make the Bush tax cuts permanent, favouring the private sector. Obama however is likely to look for a more balanced stimulus program, extending certain spending measures as well as tax cuts. According to the Congressional Research Service the estimated cost of the tax cuts would be approximately US$5 trillion between 2011 and 2020;
  • Uncertainty has been on the rise in Q2 of 2012 and is a core mechanism through which the fiscal cliff will impact the country’s economy prior to the 31st of December 2012. Gross fixed capital formation (GFCF) growth, a measure of total investment in an economy, has slowed quarter-on-quarter since a peak of 3.1% in Q3 2011 (seasonally adjusted). GFCF is expected to contract in Q2 2012 by 0.2% q-o-q, in part due to the political debate over the looming fiscal cliff;
  • The political shadow hanging over the US economy in 2012 has no precedent, however the comparatively benign example of the federal debt ceiling debate in the summer of 2011 demonstrates the effect political uncertainty can have on an economy. Consumer confidence in the month prior to and the month of the debt ceiling agreement recorded month-on-month declines averaging 7.9 percentage points;

USA Consumer Confidence: April 2011 – June 2012


Source: Euromonitor International from National Statistics Offices and trade sources


The country’s economic outlook has become increasingly fragile in 2012. Real GDP is forecast to slow in Q2 and Q3 of 2012; on a seasonally adjusted basis real GDP growth is expected to fall to 0.2% over the previous quarter by Q3 2012. Current debates in congress are likely to further delay business investment and consumer spending as the private sector waits for a resolution to the fiscal problem, slowing domestic and global economic growth further.

  • The congressional divide between the Republican majority in the House of Representatives and the Democratic majority of the Senate means compromise will be inevitable. Although both sides have shown little will to move forward with proposals so far, Euromonitor International expects the fiscal cliff to be avoided. The weakness in the USA’s economy and the danger of recession will force the government’s hand. As a result, real GDP growth is expected to be 2.5% in 2013;
  • It is important to note however the USA’s economic woes are not set to the end with the fiscal cliff issue. Another increase in the federal debt ceiling is required in early 2013 as the country continues to run a budget deficit, providing further opportunity for political conflict and financial market disruption. The continued political obstinacy could contribute to further uncertainty in the US and global economies.