Fiscal Cliff Update: The Canadian Impact

How the fiscal cliff update will effect CanadiansSo it looks like U.S. Democrats and Republicans have managed to avoid pulling a Thelma and Louise. They drove up right to the edge of the cliff, but slammed on the brakes before flying over. (For any of you who don’t get the reference to the 1991 hit movie, download it. At the very least you’ll get to see what Brad Pitt looked like when he was young.)

At the time of writing, markets have rallied back from the dips they took as the year-end “fiscal cliff” deadline grew ever closer without a solution in place. Here we review the fiscal cliff update, and the implications of the new measures on Canadians.

What Could Have Happened?

Much like the ultimate New Years’ Day hangover, the so-called fiscal cliff was the cumulative effect of years of overindulgence by U.S. politicians. While recognizing that the ever-increasing federal budget deficit needed to be pared back, neither side could agree on how much of it should be dealt with by cutting back spending (in simplified terms, the Republican take) or by raising taxes (the Democrats’ option, again in the simplest of terms). So a series of acts were passed that basically continued some George W. Bush-era tax cuts with the pledge that the two sides would work out their differences – or else. The “or else” part was a trillion-dollar combination of automatic spending cuts and tax hikes that totaled roughly four per cent of U.S. GDP, and would likely be enough to send the still fragile economy back into recession.

“As it turns out, Washington isn’t so dysfunctional that it would drive the U.S. economy into recession by piling on aggressive tax hikes and spending cuts in a single year,” CIBC chief economist Avery Shenfeld said in a report released January 2, 2013, the day after an agreement was finally reached.

Short-Term Gain?

The kicker to all the hoopla is that the agreement actually just kicks the can down the road to March 1st, where a new deadline hovers to finalize spending cuts. “While the U.S. is not now plunging off a fiscal cliff, it’s still going down a steep fiscal ski hill that will take a meaningful bite out of economic growth, one that could still be close to the 1.5 per cent of 2013 GDP that our forecast had assumed,” added Shenfeld.

What Does This Mean for Canucks?

We share a lot more with our cousins to the south than pop culture references. In fact, Canada and the U.S. are by far each other’s largest trading partners. And, as we’ve seen with recent housing and banking-related economic crises, anything that negatively impacts the U.S. economy has an impact here at home. (As with the housing market and banking industry, Canada’s deficit situation is also less volatile than that in the U.S.)
So prepare yourself for more economic precipice references in the coming weeks, and the volatility that will come without resolutions to the problem.

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