Normative Narratives

Economic Outlook: The Cost-Benefit Analysis of Competent Governance–Revisiting the “Confidence Fairy”


Markets around the world reacted favorably to news of a deal reached by Congress Tuesday to avert the Fiscal Cliff. The deal reflects concessions from both sides, although is largely seen as a victory for Democrats, who secured most of the Bush-era tax cut expirations on the wealthiest Americans while preserving low rates of the middle class. Obama also got the short term stimulus needed to help along the weak U.S. economic recovery, which he could not have gotten by “going over the cliff”. Neither side emerged too optimistic from the bargaining table, which probably reflects that a fair deal was reached (although don’t tell a happy VP Biden that).

By raising the maximum threshold from $200,000 (single filer) and $250,000 (joint) to $400,000 and $450,000 respectively, the G.O.P. was able to spare the majority of small businesses that would have been affected by the expiration of the Bush era tax hikes. Lower rates for middle income earners and continued government spending are likely to benefit poorer voters, those who spend a larger % of their income and therefore stimulate the economy more for every dollar of income they have (compared to a wealthier person).

Concessions and approval by the G.O.P. in the House of Representatives, the fiscal bills toughest opponent, can be seen as a means of gaining popularity among voters after tough losses in the 2012 election. The bill received wide bipartisan support in Senate, if the House failed to pass the bill the majority of the blame would’ve fallen on specifically on G.O.P House Representatives.

There has been a continuous trend over the past few months (and really much longer than that), that there is a real benefit of government effectiveness and a real cost of political tumult. During the debt ceiling debates of the summer of 2011, S & P downgraded the status of U.S. Federal Debt for the first time in history, reflecting not the unsustainability of the level of debt, but the costs of even a whisper that the U.S. would not honor its past commitments. This is not an acceptable alternative in the eyes of President Obama:

“While I will negotiate over many things, I will not have another debate with this Congress over whether or not they should pay the bills they’ve already racked up through the laws they have passed,” he said. “Let me repeat we can’t not pay bills that we’ve already incurred.”

Markets in Europe (and around the world) have also reacted favorably to positive news of greater fiscal consolidation and ECB action in addressing the European Debt Crisis. On the other hand, markets have reacted negatively to news of austerity preconditions for emergency debt financing and general pessimism over the sustainability of GIPSI (Greek, Irish, Portuguese, Spanish and Italian) debt.

Check out Trading Economics global financial markets info (you will have to search each country individually unfortunately there does not seem to be a chart for market averages by region). Each peak and valley in recent history is likely to be associated with some government action or inaction, with too many to go through individually.

Hopefully the G.O.P. will learn by positive reinforcement; markets reacting favorably will lead to a favorable response by their constituent. As with any political party, the G.O.P. is ultimately accountable to the will of the people. If this is the case, and the G.O.P. is willing to be more flexible on its position of short term stimulus spending, targeting long term deficit reduction in the form of higher taxation while addressing future spending cuts once the economy has fully recovered from the recession, then Obama’s concessions will be well worth it (and the G.O.P. will find itself with a much broader support base come 2014, and a much stronger platform to run on).

If Congress uses the debt-ceiling, as it has stated in the past, to force contractionary spending cuts into the Federal Budget, then any goodwill generated by reaching a fiscal deal in Washington is likely to be short lived. The U.S. is out of the frying pan, but whether we are “into the fire” or “in the clear” is largely dependent, for better or for worse, on the future actions of our elected officials. Let’s hope the 113th congress is more responsive to the needs of the American people than the 112th was.

Deals should not be made simply because markets will react a certain way, that’s bad politics and bad economics. Deals should be made with long term debt sustainability, short term economic recovery, and social equality / mobility as the ultimate goal. Special interests should not dictate policy that affects hundreds of millions of people nationally and billions of people worldwide.

The “confidence fairy” is real, and policy does have both immediate and long term effects on markets and economic performance. It is not, however, “moral hazard”, or high levels of debt which drive the “confidence fairy” (especially not in the short run, which is the only place the confidence fairy exists anyways, as markets tend to forgive past mistakes very quickly in search of profitability, ask Argentina).

It is government competency that has a real impact on the global economy. When governments act courageously, and work out strong bi-partisan deals that protect the interests of the majority and promote overall economic strength, markets react positively. When elected officials squabble like schoolchildren, and remain accountable only to fringe groups, nobody wins. The confidence fairy is more of a gauge of confidence in our political process then confidence in short term budget sustainability.

When policy is perceived as sustainable, business flourishes and consumers are more confident, increasing growth and reducing unemployment. When uncertainty and partisanship are the order of the day, the economy stalls and everybody loses—even those who think they have “won”.

Hopefully we have learned a collective lesson as a country and a global community from our past mistakes, only time will tell.



3 thoughts on “Economic Outlook: The Cost-Benefit Analysis of Competent Governance–Revisiting the “Confidence Fairy”

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