Fiscal cliff? Grand bargain? The economic impact of 3 budget scenarios for 2013 and beyond

Now I want to focus on the Grand Bargain scenario, modeled after Bowles-Simpson, but here are details of all three:
1. Modest Restraint:

Starting from this benchmark, our central forecast assumes that some of the newer
cliff-related measures will be implemented, at least in some form. So we have
assumed that the employee portion of the payroll tax will revert to its full level and
that new health care taxes will go into effect. The discretionary spending caps put in
place by the Budget Control Act are assumed to remain and we have also left in a
more modest version of additional spending cuts as part of a modified
sequestration. On balance, more than three quarters of the fiscal cliff is avoided, but
there still is a full percentage point of drag in the base case for 2013.

2. Fiscal cliff:

For this scenario, we are analyzing the possible effects that investors and the public
would be contemplating on the chance that there is no fix. This simulation shocks
the base case with about $600 billion in new taxes and spending cuts and
represents a worst case in that the entire policy shift shows through with no midcourse
corrections. For modeling purposes, the split is roughly $450 billion in tax
hikes initiated in the first quarter and completed in the second, and $125 billion in
spending cuts phased in throughout the year. Market reactions include a 20% selloff
in equities (roughly in line with the decline associated with the 1968 fiscal tightening
discussed earlier) that partially reverses to within 10% of the baseline path by 2015.
The simulation also includes a parallel $20/bbl drop in oil prices.
Our scenario also incorporates a 5% depreciation of the dollar, but we note that a
wide range of outcomes would be possible. …
Given the sizable U.S. fiscal disruptions assumed in this scenario, coupled with the
ongoing policy challenges in Europe, the global economy could very well approach
a point at which markets and the private sector entirely lose confidence in the ability
of policymakers to manage their economies. In the face of this parade of adverse
developments, the likely decline in global commodity prices that would ensue would
provide only a small offset

Read more: http://www.aei-ideas.org/2012/09/fiscal-cliff-grand-bargain-the-economic-impact-of-3-budget-scenarios-for-2013-and-beyond/