Yesterday’s elections in the US have resulted in a new balance of power in the country that can have a significant impact on economic policy. The Democratic party has lost control of the House of Representatives while retaining a slim majority in the Senate. This clearly presents a scenario of strong confrontation and difficulties in approving laws in almost any area, including, of course, economic policy. Given that the recovery of the US economy is still slow, as is the case in many industrialized countries, the potential stalemates can have serious implications.

With regard to fiscal policies there are several potential effects. The first  is what may happen with the tax cuts  that were approved during the Bush administration and that need to be made permanent or will expire by December 31st. The Democrats favoured extending the cuts for incomes lower than $250,000, but Republicans would like to extend them for everybody, or almost. With the new balance of power in the two chambers there will be more pressure for this second option.

What about  indirect tax increases, such as an increase in sales tax or VAT as we have seen in several European countries? This seems out of the question, as it would not be politically viable given the strong opposition to more taxes from the Tea Party and others in Congress. So, in view of its high deficit and debt, how can the country move toward a more prudent fiscal balance? Through reductions in government expenses and in public investment. The debate will center around which expenses should be decreased. Republicans may resist strong reductions on defense while favouring the privatization of other public services.

And what about monetary policy? In this scenario if somebody assumes a more important role it is the Federal Reserve. With its independence and the potential stalemates in the legislative power, the Fed will clearly play a crucial role. It will be interesting to see how its policies are adapted depending on what happens with the House of Representatives and the Senate. If there is little action, then we will probably see more agressive monetary policies.