IMF Fiscal Monitor -- Balancing Fiscal Policy Risks, April 2012
Fiscal Monitor, April 17, 2012
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- Published: April 17, 2012
- Series: Fiscal Monitor
Purpose and Scope
- The Fiscal Monitor was launched in 2009 to survey and analyze the latest public finance developments, update fiscal implications of the crisis and medium-term fiscal projections, and assess policies to put public finances on a sustainable footing.
- It is prepared twice a year by the IMF’s Fiscal Affairs Department.
- This issue examines the concept of fiscal space: the scope policymakers have to calibrate the pace of fiscal adjustment without undermining fiscal sustainability.
Short- to Medium-Term Assessment
- Overall, fiscal risks remain elevated, although there are signs that in some key respects they are less acute than six months ago.
- Debt ratios in many advanced economies are at historic levels and rising; borrowing requirements remain very large; financial markets continue to be in a state of alert; downside risks to the global economy predominate.
- Although debt ratios are expected to begin stabilizing by 2015 in the large majority of countries, the risk of a setback is high, constraining policy options.
- In 2012, deficits in the advanced economies are projected to decline on average by about 1 percentage point of gross domestic product (GDP) in cyclically adjusted terms and slightly faster in 2013.
Fiscal Multipliers and Adjustment Pace
- In the current recessionary context, the negative impact of fiscal adjustment on activity can be expected to be large, as confirmed by new work on the size of fiscal multipliers during periods of weak economic activity.
- When multipliers are on the high side, the beneficial impact of fiscal adjustment on debt ratios and spreads may be delayed.
- Policy implication: As long as financing allows, a gradual but steady pace of adjustment seems preferable to heavy frontloading.
- Adjustment should be accompanied by broad and proactive communication strategies to fuel confidence and credibility.
- Countries with fiscal space could consider slowing the pace of near-term adjustment to reduce downside risks; if growth slows further, such countries should allow automatic stabilizers to operate freely and allow the deficit to rise to avoid excess fiscal contraction.
Differences between Gross and Net Public Debt Indicators
- Since 2008 the rise in general government gross debt ratios may have overstated short-term pressures in some countries, primarily because of the surge in seigniorage and the accumulation of assets by central banks (including government paper).
- Consolidated net balance sheets of governments and central banks can reveal this effect.
- However, large central bank holdings of government debt and other assets will need to be liquidated or rolled over to the private sector as the demand for base money returns to more normal levels.
- Therefore, gross general government debt, alongside net debt, remains a key indicator of public indebtedness over the longer term.
- The process of reducing central bank balance sheets will be difficult to manage without previous or parallel medium-term fiscal consolidation.
Medium- and Long-Term Challenges
- Countries can have flexibility in the short term without having it in the longer term.
- The need to reduce debt ratios and to address pressures from entitlement spending means that very few countries have long-term fiscal space.
- The design and implementation of credible medium-term adjustment plans remains a sine qua non for most advanced, and several developing, economies.
- Progress is accelerating, but there is still a long way to go, including in the largest economies.
Fiscal Rules and Institutional Policy
- A growing number of countries are putting in place fiscal rules.
- Fiscal rules are not a substitute for specific long-term adjustment plans but can build confidence and facilitate the establishment of a political consensus on fiscal policy.
- Second-generation fiscal rules are typically more complex than earlier versions, providing greater flexibility to respond to economic cycles but with more-binding corrections for past deviations.
- Such rules raise significant enforcement and monitoring challenges.
Key Recommendations and Policy Considerations
- Calibrate the pace of near-term fiscal adjustment to avoid undue pressures on activity and employment, especially in countries with fiscal space.
- Where financing allows, prefer gradual but steady adjustment over heavy frontloading, given the size of fiscal multipliers in weak activity periods.
- Use automatic stabilizers in countries with fiscal space if growth slows further to avoid excess contraction.
- Accompany adjustment plans with broad and proactive communication strategies to build confidence and credibility.
- Implement credible medium-term fiscal consolidation to restore long-term fiscal space and enable response to future downturns.
- Develop and strengthen fiscal rules while addressing enforcement and monitoring challenges.
IMF Fiscal Monitor -- Balancing Fiscal Policy Risks, April 2012
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