GDP Gap by End of 2013 if the Fiscal Cliff is Allowed to Occur

The Congressional Budget Office has considered the effect on real GDP growth in 2013 under two alternative fiscal policies:

Under current law, the federal budget deficit will fall dramatically between 2012 and 2013 owing to scheduled increases in taxes and, to a lesser extent, scheduled reductions in spending—a development that some observers have referred to as a “fiscal cliff.” Today CBO released an analysis of the economic effects of that fiscal restraint. Under those fiscal conditions, growth in real (inflation-adjusted) gross domestic product (GDP) in calendar year 2013 will be just 0.5 percent, CBO expects—with the economy projected to contract at an annual rate of 1.3 percent in the first half of the year and expand at an annual rate of 2.3 percent in the second half. Given the pattern of past recessions as identified by the National Bureau of Economic Research, such a contraction in output in the first half of 2013 would probably be judged to be a recession. If lawmakers changed fiscal policy in late 2012 to remove or offset all of the policies that are scheduled to reduce the federal budget deficit by 5.1 percent of GDP between calendar years 2012 and 2013, the growth of real GDP in calendar year 2013 would lie in a broad range around 4.4 percent, CBO estimates, well above the 0.5 percent projected for 2013 under current law.

Using the CBO estimate of potential GDP, the gap as of 2012QI was 5.4%. CBO also expects GDP to grow by a mere 2% during 2012, which would mean that the gap at year end would still be 5.3%. If policymakers allow the fiscal cliff to occur, this CBO forecast says that the gap will grow to 6.6% by the end of 2013. If policymakers avoided the fiscal cliff in such a way that GDP grew by 4.4%, however, the gap would fall to 3% by the end of 2013. While many economists might prefer some fiscal stimulus so as to close the GDP gap even faster, maybe our best hope given this dysfunctional Congress is that they don’t impose even more austerity.