Research US: An Update On Fiscal Policy Negotiations‏

The January budget deal averted the immediate economic catastrophe but key parts of the fiscal cliff remain unresolved. Negotiations have been complicated by the fact that the US will run out of funding soon, if Congress does not raise the debt ceiling.

House Republicans will bring a bill up for a vote today, which suspends the debt ceiling until 19 May, allowing the upcoming negotiations to focus on how to reduce the budget deficit. If passed, the bill will go to the Senate for approval.

A delay in the debt-ceiling problem would ease fears of a debt default in markets but political risks remain high. The automatic spending cuts and a potential government shutdown loom in March and we expect negotiations to be tough.

The starting point
The budget deal agreed over the New Year averted the economic catastrophe that an expiry of the Bush tax cuts would have caused. However, a major part of the fiscal cliff remains unresolved, as politicians delayed the automatic spending cuts in the Budget Control Act only until 1 March. If no alternative way of cutting spending over the coming decade is found, the sequester will thus start on 1 March.

To complicate the matter, Congress also has to agree on raising the debt ceiling as the US hit the debt limit of $16.4trn on 31 December. The Treasury department is now taking extraordinary measures, primarily halting reinvestment of securities held in the G retirement Fund for Federal employees, which, according to the Treasury Secretary, will free up around $200bn in extra funding. This is enough to keep the US from defaulting on its legal obligations until somewhere between 15 February and 1 March. With the current budget deficit, which is expected to run around 7-8% of GDP, the need for additional government funding is around $1,000bn this year.

Kicking the can down the road on the debt ceiling
House Republicans, headed by speaker John Boehner, have agreed on a proposal that temporarily increases the debt ceiling. The bill will be up for vote in the House of Representatives today and we expect it to be passed with a narrow majority. In detail, the bill suspends the debt ceiling until 19 May, at which point it would be reinstated at the current $16.39trn plus however much debt was incurred to fund government operations until 18 May. This includes paying back the funds created by the extraordinary measures that are currently keeping the US funded. Hence, the $200bn in extraordinary measures will be available once again on 19 May, implying that the date where the debt ceiling becomes binding would be pushed to around mid-July.

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