Despite the recent sharp narrowing in the U.S. federal budget deficit, the U.S. fiscal policy outlook carries financial stability risks, driven by three factors (aacording to the OFR - aka, The Treasury). First, a rapid pace of deficit reduction carries economic costs. Second, a clear resolution of the nation’s long-term fiscal challenges is still lacking. Finally, the political process for implementing sustainable fiscal adjustments has become more uncertain.
Chart: Goldman Sachs
But this substantial fiscal adjustment carries two risks. First, it has created a fiscal drag on an economy that remains weak. Second, it creates an extra burden on other policy levers to support the economy. A policy mix that keeps short-term interest rates and unconventional monetary policy tools in place for an extended period potentially increases future risks to financial stability, whether through excessive risk-taking in credit markets or through volatility and interest rate shocks.
Delays in addressing long-term challenges could have longer-term, and potentially permanent, adverse financial stability consequences.
While everyone is still bleating over the success' of the budget deal (despite its betrayal), the next few months have plenty of potential mines for fiscal fragility.