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.
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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 [8]), the next few months have plenty of potential mines for fiscal fragility.