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Full steam ahead? How economy might look if 'cliff' deal is struck. (+video)

If Washington can strike a bargain on the 'fiscal cliff,' some tax hikes and spending cuts would slow the economy. But rising consumer confidence could keep the slow recovery chugging along.

By Staff writer / December 20, 2012

House Speaker John Boehner (R) of Ohio arrives to speak on the 'fiscal cliff' negotiations on Capitol Hill in Washington Wednesday.

Jacquelyn Martin/AP

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Consider this a sign of hope: As the clock ticks toward Dec. 31 with no fiscal deal in place, the stock market is holding up pretty well.

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Investors expect Congress and the White House will find a way to keep the economy from plunging headlong over that much-discussed "cliff" of tax hikes and automatic federal spending cuts at the end of the year.

Getting to congressional "yes" votes within the next 11 days isn't a sure thing, and stock prices could start struggling if the prospects for a deal come into doubt. The fact that the Republican House speaker has been pushing a "Plan B," and Democrats say they'll only consider a "Plan A," is hardly reassuring.

But for now, financial analysts and the markets appear focused squarely on a 2013 environment in which the fiscal cliff is avoided, and the economy stays out of recession.

What would that economy look like?

It would be one with scaled-back federal largess, but possibly enhanced consumer confidence.

A fiscal bargain would put some speed bumps in the nation's path, even though the deal's tax hikes and spending cuts wouldn't be of "cliff" magnitude. The policy changes might exert a slowing force equal to 1 to 2 percent of economic activity.

The good news, though, is that a deal would reduce a substantial amount of uncertainty about fiscal policy, giving businesses and consumers the confidence to offset that fiscal drag with some fresh spending.

Economists warn that financial uncertainty won't disappear entirely. It appears likely, for example, that a near-term fiscal deal will merely set the stage for more bargaining next year over reforms to costly entitlement programs, and over further tax reforms.

Add this all up, and forecasters see next year as a time of tepid economic growth, with gross domestic product (GDP) expanding by about 2 percent even as taxes rise modestly and doubts about America's long-term fiscal health persist.

Even though this wouldn't be a roaring recovery, many market strategists expect stocks to perform better than bonds. Two percent growth would be essentially the same as this year.

President Obama and House Speaker John Boehner (R) of Ohio appear to be edging toward a deal this month that would reduce projected federal deficits by about $2.5 trillion over the next decade, while leaving more to negotiate next year. (Federal budget experts have generally been calling for a fiscal reform package that would reduce deficits by $4 trillion over the next 10 years.)

A survey released this week found that business economists are expecting GDP growth of 1.8 percent next year, with job growth plodding forward at about 165,000 hires per month. That's an average forecast, with some participants more pessimistic and others envisioning solid improvement, with growth above 3 percent.

The consensus in the survey, conducted among members of the National Association for Business Economics, was that consumer spending would continue to rise at a 2 percent pace, despite the hit to incomes that may come from a boost in tax rates on the rich and an expiration of a temporary 2 percent reduction in worker Social Security payroll taxes.

While unexciting, that would be a far better outcome than a no-deal scenario.

Economists at Citigroup have estimated that if all the now-scheduled tax hikes and spending cuts went into effect, a recession next year would shrink US output by 1 percent compared with 2012, and the unemployment rate would rise above 9.5 percent from its current level of 7.7 percent. The Congressional Budget Office, has outlined a recession of similar magnitude, with unemployment above 9 percent.

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