Markets are way up today on the news of the budget deal, as everyone breathes a sigh of relief that we’ve averted big tax hikes and indiscriminate cuts to federal programs. The bad news: there’s still plenty of opportunity for a budget disaster as Congress takes up the debt ceiling and other issues in the next months.
A great number of pixels have already been spilled, and are yet to be spilled, about the economic and political implications here. Instead of adding to this storm of analysis, it’s easier to focus on an element here that’s relevant to both markets and politics: the interplay of incentives and game theory.
In the House of Representatives the vote on the budget measure was 257-161, with Democrats providing most of the votes to get it passed. House Republicans voted 151-85 against the measure. This outcome–a budget compromise backed by the Republican leadership passing over the objection of most GOP house members–is not one many would have predicted.
From a game theory standpoint, however, it looks like an excellent deal for Republicans. As the New York Times‘ Nate Silver has pointed out, the objectives of the national party on the budget differ from that of many rank-and-file members, who fear attacks from the right. This deal satisfies both constituencies. It lets most House Republicans make a stand for budget cuts without actually producing the cuts (is anyone really eager to cut Medicare reimbursement 27 percent across the board?), or opening the party to accusations of torpedoing the economy.
So despite 151 Republicans voting against the measure, it’s not clear yet whether what we’ve got is an ingenious feint, or a genuine revolt of the rank-and-file against the House Republican leadership. We’ll have an important data point on this soon enough. If John Boehner keeps his job as Speaker of the House in the incoming 113th Congress, which still appears likely, we’ll have an indication that many of those 151 Republicans tacitly support the deal they voted against. If he doesn’t then it’s a sign that there’s a bona fide revolt, and that the next months could be even more rancorous than the last.
PS: Lots of other folks have tried to play out the incentives in the fiscal cliff debate, from academics to the New Yorker‘s John Cassidy. It looks now like what most of the analysis missed was that this wasn’t a two player contest, but one with several parties (the Democratic administration, the national GOP, Tea Party-backed House Republicans) aiming at somewhat different outcomes.
Update, Jan. 3: Boehner was indeed re-elected Speaker–with the votes of 220 out of 233 Republicans in the new House of Representatives. So that’s one question answered, isn’t it?
A version of this post appeared earlier in the Market Now newsletter. Click here to register at Bloomberg.com and subscribe to The Market Now daily email.