Don’t Let Fiscal Brakes Stall Global RecoveryA Commentary by Christine Lagarde, Managing Director, International Monetary Fund
Published originally in Financial Times
August 16, 2011
The current market turmoil, marked by a huge spike in uncertainty, has shaken confidence across the global economy and prompted many to conclude all policy options have been exhausted. That impression is wrong – and could lead to paralysis.
After the crisis unfolded in late 2008, global policymakers came together to act with common purpose. Their efforts saved us from a second Great Depression, by supporting growth, attacking sclerosis of the financial arteries, rejecting protectionism and providing resources to the International Monetary Fund. It is time to rekindle that, not only to avoid the risk of a double-dip recession, but also to put the world on the path of solid, sustained and balanced growth.
The situation today is different from 2008. Then, uncertainty came from the poor health of financial institutions. Now, it comes from doubts about the health of sovereigns and the tricky feedback loop to banks. Then the answer was unprecedented monetary accommodation, direct support for the financial sector and a dose of fiscal stimulus. Now monetary policy is more constrained, banking problems will again have to be addressed, and the crisis has left behind a legacy of public debt – about 30 percentage points of gross domestic product higher than before, on average, in advanced countries.
So there are no easy answers. But that does not mean there are no options. For the advanced economies, there is an unmistakable need to restore fiscal sustainability through credible consolidation plans. At the same time we know that slamming on the brakes too quickly will hurt the recovery and worsen job prospects. So fiscal adjustment must resolve the conundrum of being neither too fast nor too slow.
Shaping a Goldilocks fiscal consolidation is all about timing. What is needed is a dual focus on medium-term consolidation and short-term support for growth and jobs. That may sound contradictory, but the two are mutually reinforcing. Decisions on future consolidation, tackling the issues that will bring sustained fiscal improvement, create space in the near term for policies that support growth and jobs.
By the same token, support for growth in the near term is vital to the credibility of any agreement on consolidation. After all, who will believe that commitments to cuts are going to survive a lengthy stagnation with prolonged high unemployment and social dissatisfaction?
Will the markets buy such an approach? In some countries, they seem to be pushing for sharp fiscal adjustments. And some policymakers have decided that is the road to follow. But in many countries a short-term focus would be wrong. We should remember that markets can be of two minds: while they dislike high public debt – and may applaud sharp fiscal consolidation – as we saw last week they dislike low or negative growth even more.
Of course, the amount of short-run policy space differs by country. High debt countries under market pressure have little leeway, and must continue fiscal consolidation. But in others there is scope for a slower pace of consolidation combined with policies to support growth.
Debt-reduction strategies must be based on concrete and substantive commitments – not just words – but the impact on the economy can be set with a delay. Policy actions can focus on areas where the pressure is mounting tomorrow, but have little effect on demand today – such as reforming entitlements or restructuring the tax system. At the same time, short-term measures must be supportive of growth, yet economical in terms of the impact on fiscal sustainability, and can include policies supporting employment creation, advancing planned infrastructure and easing adjustment in housing markets.
Nor will spending cuts alone do the trick – revenues also must increase, and the first choice must be measures that have the lowest effect on demand. Of course, there is more to do than untangle the fiscal consolidation conundrum, including getting monetary policy right – interest rates should remain low in most advanced economies, and central banks in core economies should stand ready to dive once more into unconventional waters should the need arise. Financial sector repair also remains essential: recapitalising and restructuring good banks, closing bad banks – and addressing the lack of transparency that clouds financial markets. Finally, structural reforms will take a while to have impact but efforts to boost productivity, growth and employment should start today.
Can all this be done? The notion that the current global conjuncture leaves us bereft of policy options is wrong. As in 2009, we have reached a point where actions by all countries, doing what they can, will add up to much more than actions by a few. The priorities are clear: credible, medium-term fiscal consolidation, combined with aggressive exploration of all possible measures that could be effective in supporting short-term growth.
If the global recovery falters, the burden will be borne far and wide. If policymakers can act boldly, act together and act now on these priorities, confidence can be restored and the recovery sustained.