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European Crisis, U.S. Deficit Pose Risks for Economy

Posted on November 18, 2011

Challenges on both sides of the Atlantic – the European debt crisis and the uncertain outcome of the Congressional budget-cutting “super-committee” – threaten to derail a strengthening U.S. recovery, economist Nigel Gault said this morning.

Nigel GaultThe chief US economist for IHS Global Insight told the AIM Executive Forum that the U.S. could veer toward recession if the Eurozone crisis ignites a financial contagion. The stakes for the super-committee are less immediate, Gault said, but a failure by the panel to develop a comprehensive debt reduction strategy next week would nevertheless still create significant fiscal uncertainty throughout an election year.

“The recent news on the economy has been much better than we could have anticipated three months ago,” Gault said. “The question is whether it the economy will be blown off course by these policy issues.”

Gault told the audience that many observers expect that the super-committee will fall short of its mandate to reduce the federal deficit by $1.2 trillion through a combination of increased revenue and reduced spending. He noted that the entire concept of the super-committee grew out of a political impasse in August over raising the debt ceiling, and that there is little evidence that anything has changed since then.

He said employers will be able to judge the success of any super-committee recommendations by several factors:

  • Does it achieve $1.2 trillion in deficit reduction?
  • Are entitlements (social security, Medicare, Medicaid) and revenues both contributing to the cut in the deficit?
  • Are the spending cuts real? Or spending that was never going to happen anyway? Or asset sales?
  • Are revenue increases explicit? Or “to be decided later” by tax committees?
  • Is there provision for extending near-term stimulus – at least for keeping the 2 percent payroll tax cut and emergency UI benefits in 2012?

“Failure by the super-committee would not have the cataclysmic consequences that failing to raise the ceiling would have had,” said Gault, a frequent national television commentator.

The crisis in Europe, according to Gault, provides a cautionary tale for U.S. policymakers about the danger of unbridled growth in debt.

He said that sovereign debt in Europe, like subprime mortgages in the United States, was long treated as riskless. That view led countries like Greece to run up debt equal to 125 percent of gross domestic product, and Italy to hit 100 percent of GDP, without the economic growth to sustain the borrowing.

The European crisis will eventually turn, Gault concluded, on the willingness of Germany and the European Central Bank to affirm their commitment to the union by providing more assistance to weaker nations.

View Nigel Gault’s Presentation Slides