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Will We Fall Off A ‘Fiscal Cliff’?

A cliff is a steep face of rock that overlooks something, like a canyon or a city. And putting a clever spin on the word, Federal Reserve Chairman Ben Bernanke is warning that we are skirting the edge of a “fiscal cliff” that has the potential to derail the economy.

The “fiscal cliff” is made up of a few things that will happen at the end of the year: the expiration of the Bush tax cuts and the payroll tax holiday, automatic spending cuts, and the end of extended unemployment benefits. The impending changes were triggered when the “super committee” failed to come up with a way to close the budget gap.

On the one hand, the super committee’s ‘failure’ was really a success in that it would force automatic cuts which would, in turn, reduce the deficit. But now that those changes are looming, the potential impact is coming into focus.

If Congress does nothing, the cliff will amount to hundreds of billions being pulled out of the economy… almost overnight. And it will shave easily 3.5% off of our economic growth. That would be enough to wipe out the recovery and push us into another recession.

And the Fed would be powerless to stop it. “If no action is taken by the fiscal authorities….there is absolutely no chance that the Federal Reserve would be able to have the ability whatsoever to offset that effect on the economy”, according to Bernanke. Or, in other words, ‘Congress, don’t mess this one up, because we can’t clean it up’.

While allowing tax cuts to expire and allowing spending cuts to go into effect would strangle the economy, doing the opposite (extending tax cuts and canceling spending cuts) would add something like $5 trillion to the country’s debt (based on the CBO’s alternative scenario).

But that’s not a very likely scenario. As it is, we will, inevitably, hit the debt ceiling later this year…again.

So will the economy fall off a cliff? Not likely. We will be pulled back from the precipice. That Congress would do nothing is a worst-case scenario that won’t happen. The reality is, of course, something will be done. Congress has proven to be very good at kicking problems further down the road when they need to.

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