The most likely situation is this. After much shouting, a fiscal deal is reached in the new year – with a headline adjustment of around $1 trillion over 10 years, and perhaps with a 50-50 split between tax increases and spending cuts. Public attention recedes. Commentators proclaim that the budget problem has been fixed.
But then we hit a real fiscal crisis, with foreigners declining to buy newly issued Treasury paper and interest rates on that debt – and interest rates more broadly throughout the economy – rising sharply. The Federal Reserve fights to keep interest rates down, but its monetary policy in that instance is regarded as inflationary, further destabilizing the situation.
That crisis – date unknown but intense for sure – forces much more damaging fiscal cuts, including cuts in Medicare but also across the board (and bringing higher taxes). This is exactly the kind of disruptive fiscal austerity that damages an economy. One such dramatic, even humiliating, potential scenario is described in gripping detail in the opening pages of “Eclipse” by Arvind Subramanian (my colleague at the Peterson Institute for International Economics).
We end up poorer, more unequal and struggling to remember how we ever cared for one another in old age.