What is Fiscal Cliff?

What is Fiscal Cliff?

The phrase "fiscal cliff" was first used by Fed chairman Ben Bernanke to refer to the combination of tax increases and spending cuts that would come into effect at the end of the year. Here's a look at the possible consequences:

What impact will the fiscal cliff have?

A number of tax cuts, including Bush-era tax cuts, and unemployment benefits will expire almost together at the year-end. The result would be a drop in government spending and lower disposable incomes.

These tax benefits and higher government spending had supported the economic recovery at a time when private sector demand was low.

Expiry of tax benefits and lower government spending would help reduce the federal budget deficit but could temporarily arrest economic recovery, possibly even driving the US into a recession during the first half of the next year.

What does it imply for the rest of the world?

The current fiscal policy in the US has raised concerns over the country's long term fiscal stability and solvency. The increase in taxes and lower government spending are part of the solution.

But if the tax increases and spending cuts are allowed, the resulting recessionary climate would then cloud the prospects of even the fastest-growing economies, China and India.

Why is it a big talking point now?

It has become a big issue because the US presidential elections are due in November, which will leave little time for the new president to take appropriate action. Also, due to political reasons neither party in the US is backing down from its demands.

While the Dems want a combo of tax increases and some benefits, the Republicans want tax cuts coupled with benefit reductions.

So what is the alternative?

The two parties could arrive at a compromise before the elections start, which could calm financial markets. But so far they haven't shown any inclination to talk; probably both are waiting to see who will have more negotiating leverage