Today, Moody’s, one of the largest credit rating agencies, released a statement warning of a downgrade to the U.S. debt.
Although the U.S.’s current rating is a Aaa, the highest rating given by Moody’s, Moody’s warned in their statement that the U.S. retention of its rating is contingent on what happens with budget negotiations.
“If those negotiations lead to specific policies that produce a stabilization and then downward trend in the ratio of federal debt to GDP over the medium term, the rating will likely be affirmed and the outlook returned to stable”, says Moody’s.
Moody’s threatened that if policies of this nature are not implemented, then the U.S. would more than likely have its rating downgraded to an Aa1, the next highest rating given by Moody’s.
One fiscal policy scenario entertained in Moody’s statement is the coming fiscal cliff. According to Moody’s, the most realistic scenario for the “temporary maintenance” of the U.S. rating would be an “immediate fiscal shock—such as would occur if the so-called "fiscal cliff" actually materialized.”
One of the problems with the conclusion reached by Moody’s is it doesn’t fully account for the negative impact that austerity of this magnitude would have on the U.S. economy. The CBO and Federal Reserve both came out recently to warn of an almost certain recession if tax cuts are not extended. In light of this, how can Moody’s improve the outlook for an economy expected to experience a double dip recession in the scenario given?
Moody’s may be coming at this from the perspective that the U.S. needs to take drastic measures to improve the outlook of the U.S. debt situation; however, how can the U.S. be expected to service a tremendous debt load during a recession?
Debt is much easier to service during times of prosperity than recession. Therefore, the last thing that the U.S. needs is one of the largest tax hikes in its history amid a recovery.