The fiscal cliff is a danger to the economy. Some have argued
that cliff diving is benign either because the cliff itself is
an illusion – it is really a gentle slope – or because
policymakers have the cartoon-like power to reverse going over
the cliff without hitting the abyss. Both arguments miss the key
role that would be played by financial markets. Cliff diving
would have a significant impact on financial markets, impairing
asset values, exacerbating credit stringency and amplifying the
direct effects on the Main Street economy. These effects cannot
be “unwound” by retroactively legislating away the fiscal cliff.
Taken at face value, the fiscal cliff is a large negative policy
shock. The tax increases are nearly $400 billion and the
spending cuts about $145 billion. The total, $540 billion is
roughly 3 percent of gross domestic product. For perspective,
trend economic growth now appears to be less than 2 percent —
but certainly nowhere close to 3 percent. If one uses the
multiplier estimates of Christina