Brad DeLong bemoans the Obama administration’s weak approach to the debt limit as opposed to the fiscal cliff:

In any negotiation, you first want to prepare the ground so that failing to make an agreement creates a situation that your counterparty absolutely hates–that even what is from their perspective a bad deal is better from their standpoint than no deal–and so that failing to make an agreement creates a situation that you rather like–so that only what is from your perspective a very good deal is better than no deal…

With respect to the debt ceiling, however, no effort has been made to prepare the ground at all: no steps have been taken to signal what actions the administration will take after the debt ceiling has been reached that will make the situation one that Republican politicians will hate and that Democratic politicians can live with. And without such a strategy in place, the Obama administration has no bargaining power on the debt ceiling.

Here’s my rationale: There are two negotiations going on. The Obama administration would like to resolve the fiscal cliff deal in their favor as soon as possible. The Republicans are worried that the tax increases that will ensue if negotiations fail will rebound to their disadvantage. They know that they will have more leverage in the debt limit negotiations that will soon follow. Hence, they are more likely to concede in the fiscal cliff negotiations if they think they will be in strong position in the debt limit negotiations. If Obama explores constitutional solutions to the debt limit increase that sidelines the House, this will impact the fiscal cliff negotiations. Then, the Republicans will be less likely to concede the middle class tax cut now and bargain about entitlements later because they will believe they have less leverage later.

Therefore, Obama should not bring up any exit option from the debt limit negotiations. No trillion dollar platinum coin should be invoked right now. Of course, when the debt limit does come up, the coin comes out. Ha ha.

But we can take this one step further in the usual hall-of-mirrors style of game theory. The Republicans know all the analysis above and have done it themselves. Hence, they know they will have no leverage in the debt limit negotiations as Obama will then pull out the platinum coin from his pocket. Hence, the only leverage they have is via holding up the middle class tax cut. Hence, Obama is in a weak position in the fiscal cliff negotiations and in a strong position in the debt limit negotiations. Of course, his threat point is the fiscal cliff taxes, sequesters etc. but at the risk of causing a recession next year. So, really, in superrational backward induction world, everyone has the analysis backwards – Obama weak now, strong later.

But hold on, this is not only assuming a lot of backward induction but also certainty that the platinum coin or some other constitutional fix works. We cannot be sure. Hence, the Republicans do have some leverage in the debt limit negotiations. Their wiggle rom comes from this uncertainty. But then we are back at square one!

Or we can throw up our hands, say this is all too complicated, and stick with my simpler rationale…..

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