Sept 27 - The US fiscal cliff represents the single biggest near-term threat to a global economic recovery, Fitch Ratings says. While it is not our base case, the dramatic fiscal tightening implied by the fiscal cliff could tip the US and possibly the global economy into recession. At the very least it would be likely to halve the rate of global growth in 2013.
Under current law US tax increases and spending cuts worth USD600bn, equivalent to 4% of GDP, will take effect in fiscal 2013. With most of the measures scheduled to take effect at the beginning of calendar 2013, the fiscal contraction would be equivalent to more than USD800bn (5% of GDP) on an annualised basis, according to the Congressional Budget Office. The scale and speed of this fiscal tightening would be likely to push the US economy into an unnecessary and avoidable recession. We therefore think the cuts will be pared back to a more manageable 1.5% of GDP (see our Special Report, “US Fiscal Outlook - Mired in Uncertainty”, published in July 2012 for more detail).
However, if the fiscal cliff did involve USD600bn of permanent fiscal tightening, it would knock almost two percentage points of our 2013 growth forecast of 2.3%, according to our alternative scenario analysis detailed in the “Global Economic Outlook” published today. The gap with our baseline GDP level would be almost three percentage points in 2014, before narrowing slowly.
This would have a global impact. According to the Oxford Economics model used in our alternative scenario analysis, a US fiscal shock would be exported to the rest of the world via a sharply weaker US dollar and asset prices, lower US price and wage inflation and heightened risk of deflation, and the impact on commodity prices.
Model simulation results show the major consequences for the global economy. As domestic demand fell, US imports would drop faster than exports, and the resulting improving trade balance would need to be matched by deterioration in trading partners’ balances, causing growth to slow. While the world economy would still grow 1.3% in 2013, this is just half our baseline forecast of 2.6%. The potential contagion effects from greater stress in the US financial sector and asset markets could further amplify the negative effects on the global economy.
The size and timing of the shock would be different for different countries. Export-orientated countries like China and Japan would experience the steepest falls in GDP in 2013. Growth would then resume at baseline rates, but at a lower level. Commodity exporters like Russia and Brazil would be less affected in 2013, but the effects would be felt into 2014.
Some policy response by US trade partner countries is assumed in the model. However, the size of the shock may mean that they respond on a scale outside the model’s parameters. In particular, it could amplify the risks of uncoordinated “beggar-thy-neighbour” actions, as some countries would feel tempted to limit the appreciation of their currencies versus the US dollar.