Question

What is a fiscal cliff that a government can have occur?

Answer 1

The so-called "fiscal cliff" refers to the political impasse between Congress and the White House, regarding increases in the debt ceiling during the Obama Administration.

Explanation:

While this is mostly a political dispute, it clearly involves macroeconomics. We have, in the U.S. a rather large federal budget, and for most of the past 40 years or so, we have had mostly annual deficits. I believe we had one year of federal budget surplus, during the final year of the Clinton Administration. In any case, a deficit always adds to the national debt.

Budget balance (Revenue - Expenditures) is a measure of "flow" during the fiscal year. A deficit is a negative budget balance and increases the level of national debt, by exactly the amount of the deficit. Likewise, a surplus is a positive budget balance and reduces the level of national debt, by exactly the amount of the surplus.

So, for most of the past 40 years, we have been increasing the national debt. The ratio of national debt to GDP (debt to "income", in a way), is close to 100% - and may observers think that is an urgent issue and unsustainable. From a macroeconomics perspective, I think the mainstream theories about sustainable deficits and debt mostly conclude that deficits are not necessarily always bad for the economy, but that we need to manage them.

The politics would distract from the basic economic analysis here -- which is somewhat inconclusive. Economists generally agree that deficits can actually be helpful in stimulating an economy during periods of recession. But, the theories supporting this argument suggest that surpluses, likewise, would be more appropriate policies during periods of excessive expansion. None of these considerations actually get any attention at all during the political crisis known as the fiscal cliff.