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JPIrving on why not to fear the fiscal cliff

Turn on the TV and watch five minutes of CNBC or Bloomberg TV these days and you get the impression that the world is coming to an end as a result of the fiscal cliff. However, the contrast to this is the development in the US financial markets. Yes, there are some jitters in the markets, but the market developments do not exactly indicate that we falling into the abyss in a couple of days. This is the theme of a new excellent post from JPIrving.

Here is JP:

“In a situation like this, the thing to do is to look at the markets to get a sense of what they foresee. However reading markets is not so straightforward in this situation. Unlike monetary policy, which is more or less neutral in its impact on the composition of aggregate demand (where the ‘money goes first’), fiscal policy is by definition nonneutral. If the government cuts the military’s equipment budget, then military contractors stand to lose more than others.”

JP is right – if the markets really were fearing a collapse in aggregate demand then we would see a collapse in the stock markets and we haven’t seen that.

JP continues:

“If we would say that there is a 40% chance of taking on the full fiscal cliff, and that markets are already discounting this, I would say that the full fiscal cliff would not have the sort of disasterous consequences some fear. At least this is what the markets say to me.

Some regions would be hard-hit, but the recovery would survive.”

Let me just say I wholeheartedly agree.

PS Some (Johan Weissmann at The Atlantic) tells us to worry about a “Diary cliffs” as well. However, the market is not worried. I tend to believe the market, but Weissmann is right that US politicians behave as small children.

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