While my modal outlook calls for only a gradual reduction in labor market slack and a stable pace of inflation near the FOMC’s longer-run objective of 2 percent, I see substantial risks to this outlook, particularly to the downside. As I mentioned before, even without any political gridlock, fiscal policy is bound to become substantially less accommodative from early 2013 on.
However, federal fiscal policy could turn even more restrictive if the Congress does not reach agreement on several important tax and budget policy issues before the end of this year; in fact, the CBO recently warned that the potential hit to gross domestic product (GDP) growth could be sufficient to push the economy into recession in 2013.