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Brooks Wilson's Economics Blog: The IMF and S&P on Playing Chicken

Wednesday, June 22, 2011

The IMF and S&P on Playing Chicken

In “Political Chicken and the Debt Ceiling” I compared the current impasse between Democrats and Republicans were playing a game of chicken.  Incumbent politicians, the drivers and voters, the bystanders are affected.  The outcomes for voters differ from those of politicians and depend more on the economic outcome of the political game.  Incumbent politicians gain or lose votes depending on the outcome of the game and voters gain or lose from the nation’s change in financial stability which is again an outcome of the game.  Both parties are using the debt ceiling crisis to leverage a solution to the larger and looming sovereign debt crisis. 

The worst outcome is for both parties to hold their course and fail to raise the debt ceiling.  Incumbent politicians in both parties lose votes.  Voters lose as well because the impasse would trigger a financial crisis.  The best outcome for a party is for the other party to swerve or capitulate, accepting the other party’s solution.  Voters gain or lose depending on which party’s plan best solves the sovereign debt crisis.  A compromise does not affect incumbents but is better for voters than a political impasse and has the potential to be better or worse than one party capitulating to the other.  Hopefully, a compromise might include the best ideas of both parties but could include the worst, or more likely still, something between the best and worst of each plan.

I prefer tying the increase in the debt limit to cutting the budget deficit.  The remainder of the post quotes to articles, one I believe that supports my position and another that does not.  In “IMF cuts U.S. growth forecast, warns of crisis,” Luciana Lopez writesblockquote>SAO PAULO (Reuters) - The International Monetary Fund cut its forecast for U.S. economic growth on Friday and warned Washington and debt-ridden European countries that they are "playing with fire" unless they take immediate steps to reduce their budget deficits. Yet that relatively benign global outlook could quickly fall apart if politicians in the United States and Europe do not start showing more leadership in addressing their countries' debt problems, the fund warned...

"You cannot afford to have a world economy where these important decisions are postponed, because you're really playing with fire," said Jose Vinals, director of the IMF's monetary and capital markets department.

"We have now entered very clearly into a new phase of the (global) crisis, which is, I would say, the political phase of the crisis," he said in an interview in Sao Paulo, where the updates to the IMF's World Economic Outlook and Global Financial Stability Report were published.In “S&P restates political threat to U.S. AAA rating,” William James and Emelia Sithole-Matarise write

The risks of the U.S. losing its prized triple-A rating over the medium term have increased as the country faces a political impasse and nears its debt ceiling, Standard and Poor's said on Tuesday.

While the ability to adapt both fiscal and monetary policy was a positive for the United States, the risk of a credit rating downgrade had increased due to a lack of political consensus on how to employ that flexibility, Moritz Kraemer, head of sovereign credit ratings for Europe at Standard & Poor's, said on Tuesday.

"The problem is this flexibility needs to be employed and for that you need political consensus. That's not very visible right now," he said.

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