Finally, America is on the verge of a major step towards reducing its dangerous and long-term fiscal deficits. This was seen as impossible six months ago. But a combination of growing public antipathy to deficits and fierce opposition to raising the federal debt limit this summer has changed the environment, and put Congress into a bind. It must raise the debt ceiling to enable continued national borrowing and avoid a catastrophic default. So, for political protection, its members now want to deliver a simultaneous, large deficit reduction package. Negotiations focus on $1,000bn-$2,000bn of reduction over 10 years, against an August 2 deadline on the debt limit. It may occur at midnight, but an agreement is likely.
Congressional and White House negotiators have to settle on sector-by-sector reductions. Just setting future targets will not be credible. The approach also should be broad, including reductions in tax expenditures and entitlements. But, even a $1,000bn deal would represent a quarter of the amount ultimately needed to stabilise the debt/gross domestic product ratio and solve the problem. Crucially, it would reassure everyone that America is moving to fix this problem which is so threatening. Such an agreement would be an unambiguous plus, with one, key caveat.
Namely, the already anemic economic recovery has recently slowed further. The evidence is clear, which is why share prices have fallen for six straight weeks. This weakness has three implications for the deficit negotiators: they should still press ahead to reach agreement; the effective date of their reductions should be 2013, not next year; and the three stimulus measures adopted in December last year should be extended one more year.