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We've Already Gone Over the Fiscal Cliff

By Caroline Baum
December 27, 2012 12:05 PM EST

It's official -- or almost official.

"Nearly all the major players in the fiscal cliff negotiations are starting to agree on one thing: A deal is virtually impossible before the New Year," Politico reports.

A reasonable person monitoring the budget negotiations would have already abandoned any hope of a Grand Bargain, or even a miniaturized version of a deal to avert the automatic spending cuts and tax increases in the new year. The best one could have hoped for was some kind of patch that, yes, kicked the proverbial can down the road, where it would rattle around until some crisis forced Congress's hand.

Consumer confidence took a dive this month because of the increased likelihood of going over the fiscal cliff, according to the University of Michigan Survey of Consumers. Business confidence was already in the dumps. Holiday sales were lousy. Economists are predicting another recession unless Congress acts.

World stock markets were stable this morning, suggesting the worst outcome in regard to the fiscal cliff is "already in the market," as the pros like to say. U.S. stock indexes slumped around 10 a.m. when Senate Majority Leader Harry Reid reiterated what had already been reported: that a year-end deal was unlikely.

Here's what I'm wondering. The economics profession worships at the altar of rational expectations theory: the idea that our behavior is based on expectations about the future, so the future is now, so to speak. It's what drives the Federal Reserve's communication policy. Policy makers believe that pledging to hold the overnight rate at close to zero until a certain date (old testament) or specific unemployment threshold is reached (new testament) will accelerate the economic recovery.

I have lots of issues with expectations theory. But if academics are correct, and the public expects the U.S. to go over the fiscal cliff, why is going over it such a big deal?

(Caroline Baum is a Bloomberg View columnist. Follow her on Twitter.)

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