Thanks, Tea Baggers. icon_rolleyes.gif

JP Morgan - North America Economic ResearchAs you are no doubt aware, a deal appears imminent to resolve the debt ceiling impasse. Our Washington colleagues believes this will pass in the Senate and, with some arm-twisting by party leadership, in the House as well. The main points of the plan are:

* A $2.1 trillion increase in the debt ceiling, which should tide the Treasury over until sometime after the November 2012 elections

* Around $900 billion of spending cuts over the next 10 years through reductions in discretionary outlays, including what appears to be more defense spending cuts than were in prior proposals

* Creates a bipartisan, bicameral commission tasked with finding another $1.5 trillion in deficit reductions, including through entitlement and tax reform, by November 23, which would receive and up-or-down vote in Congress by December 23.

* Requires Congress to vote on a balanced budget amendment. Like most economists, we think this is a terrible idea and would, for example, have made the last downturn much worse. In the event, we don't think this will achieve either the required approval of 2/3rds of the Congress or 3/4ths of state legislatures needed to amend the Constitution.

We see four main economic implications of this deal

1) No default. This had always been a low probability (<1%) very high cost outcome, which now seems off the table.

2) An eventual S&P downgrade is still more likely than not, though we think this would occur after the fiscal commission completes its task later this year. We don't think a downgrade is of first-order importance for economic growth: conditional on fiscal metrics such as debt-to-GDP ratios, we see no major implications for borrowing costs due to the actions of one or more rating agencies.

3) No stabilization in longer-run fiscal outlook. A stable debt-to-GDP ratio, commonly associated with sustainable fiscal policy, is not achieved within the ten -year horizon. Thus, this agreement should be seen more of a first step toward sustainability.

4) Impending fiscal drag for 2012 remains intact. The deal does nothing to extend the various stimulus measure which will expire next year: we continue to believe federal fiscal policy will subtract around 1.5%-points from GDP growth in 2012. Its possible the fiscal commission could do something to extend some measure such as the one-year 2% payroll tax holiday, though we think unlikely, as it would need to be paid for, which would be tough. If anything, the debt deal may add modestly to the fiscal drag we have penciled in for next year.

On points 3) and 4) we will have a better sense of the magnitudes when CBO completes its score of the deal, which should occur sometime today.