Monday, November 19, 2012
Fiscal cliff lessons from the eurozone crisis
November 19, 2012
As the deadline to avert the fiscal cliff gets closer, US policy makers may want to learn some lessons from the way eurozone authorities managed their crisis. Let’s consider four.
The first is that policy authorities tend to act too late, after financial markets have lost confidence. This is because of a belief among policy makers that the unpopularity of decisions will diminish only when voters understand that the alternative is much worse. Only on the verge of disaster do citizens understand that unpalatable policies are necessary. But by that point, financial markets start questioning the determination and ability of policy makers to face the situation and tend to lose confidence. At that point, even more unpalatable actions may be required.
The eurozone experience has shown how costly such a strategy can be. For instance, finding a consensus in Germany for providing financial support for Greece became possible only when the crisis reached a peak, in May 2010, and the euro seemed at risk. But at that point the size of the overall package required to stabilise the markets had risen substantially.
If the US authorities follow the same path and wait for market pressure to force a compromise, the decision might be more acceptable to both sides, being the last resort, but the burden on the economy might be dear. The sooner a solution is found, the less costly it is.