The months-long political standoff over fiscal policy has already taken its toll, adding uncertainty that has discouraged consumers from spending and businesses from hiring and investing.
The fiscal cliff, with its Jan. 1 deadline to reach a deal over taxes and spending, was created to force Democrats and Republicans to compromise, and it barely succeeded. Without a deal, more than $500 billion in tax increases would hit the economy in 2013 alone, along with $109 billion in cuts from the military and domestic spending programs.
Negotiations to avert catastrophe have highlighted once again how far apart the two parties are on taxes (Republicans don't want to raise them) and spending (Democrats are reluctant to cut government programs).
"What induces the two sides to stop fighting and start compromising?" asked Ethan Harris, co-head of global economics at Bank of America Merrill Lynch.
Political gridlock has been rattling financial markets and shaking consumer and business confidence the past two years.
After a fight over raising the debt limit last year, the credit rating agency Standard & Poor's yanked the U.S. government's blue-chip AAA bond rating because it feared that America's dysfunctional political system couldn't deliver a credible plan to reduce the federal government's debt. S&P warned that "the differences between political parties have proven to be extraordinarily difficult to bridge."
The Dow dropped 635 points in panicked selling the first day of trading after the S&P announcement.
Outside Washington, the economy has been getting some good news. Europe's financial crisis appears to have eased. And the U.S. real estate market finally appears to be recovering from the housing bust.
But partisan divide has left businesses and consumers wondering what's going to happen to their taxes and to federal contracts.
Companies have plenty of cash. But they reduced spending on industrial equipment, computers and software from July to September, the first quarterly drop since mid-2009 when the economy was still in recession. And hiring has been stuck at a modest level of about 150,000 new jobs per month this year.
Consumer confidence fell in December for the second straight month, according to a survey by the Conference Board, which blamed the drop on worries about the fiscal cliff. The uncertainty is also believed to have hurt holiday shopping, which grew at the slowest pace this year since 2008.
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