Fiscal Adjustment: Too Much of a Good Thing?

IMF Blog, January 30, 2012

Source details

Author: Carlo Cottarelli
Date: January 30, 2012
Theme: Trade-offs between the speed of fiscal adjustment and its impact on growth and market confidence.
Languages noted: عربي, 中文, Español, Français, Русский, 日本語

The Fiscal Monitor update shows fiscal adjustment is proceeding quickly in the advanced economies—on average the deficit is projected to fall by a total of 2 percentage points of GDP in 2011-12.
The decline is larger in the euro area—about 3 percentage points of GDP.
In a reasonably good growth environment this pace would be fine; in the current weaker macroeconomic environment bringing deficits down this quickly could pose a risk for the economic recovery.
Aggressive fiscal adjustment can lower interest rates via improved fiscal credibility, but it can also directly hurt growth.

Markets dislike large debt and fiscal deficits, but they also dislike low growth.
Standard and Poor’s warned that “a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers’ rising concerns about job security and disposable incomes, eroding national tax revenues.”
IMF analytical work indicates:
- Lower debt ratios and deficits lead to lower interest rates on government bonds.
- Faster short-term growth also reduces interest rates.
- When fiscal tightening slows growth, some gains from better fiscal fundamentals are lost through lower growth.
- Evidence of a nonlinear relationship: sovereign bond spreads are more likely to increase when growth is already lower and the fiscal tightening is larger.
If growth falls enough due to fiscal tightening, interest rates could rise even as deficits fall.

For advanced economies with limited access to financing:
- They may have no option but to stick to deficit reduction plans this year.
- Fiscal tightening should not be the only tool to restore market confidence; structural reforms to boost competitiveness and growth are critical.
- Adequate financing support should be provided to countries adjusting at an appropriate pace—for the euro area, via the European Financial Stability Facility and the European Stability Mechanism—to boost confidence while market perceptions adjust.
For advanced economies with more fiscal space:
- If growth slows, they should avoid further fiscal tightening and allow automatic stabilizers (revenue falls and higher unemployment-related spending) to raise the deficit temporarily.
- Some countries, including in the euro area, have very low interest rates or other factors creating adequate fiscal space to reconsider the pace of deficit reduction this year.
United States example:
- Based on current policies, the deficit would decline by over two percentage points of GDP in 2012, the largest single year adjustment in four decades.
- Policy recommendations for the U.S. include renewing the payroll tax cut and extending unemployment compensation for the long-term unemployed to provide support.
- Such short-term support would be facilitated by adoption of credible medium-term adjustment plans, which are still missing in some key economies.

Government debt remains very high in many advanced economies; medium-term fiscal adjustment to bring debt down is essential.
Nearly all advanced economies plan to reduce their deficits this year.
If growth slows more than expected, policymakers should generally avoid additional fiscal tightening unless compelled by financing constraints.
Bottom line for policymakers: unless you have to, you shouldn’t tighten further when growth weakens.

IMF blog post by Carlo Cottarelli, January 30, 2012.

iMFdirect 博客：财政调整 - 过犹不及？2012年1月29日
- iMFdirect 博客：财政调整 - 过犹不及？2012年1月29日 (Markdown version)
- iMFdirect 博客：财政调整 - 过犹不及？2012年1月29日 (PDF)
財政調整：過ぎたるは及ばざるがごとし?; カルロ・コッタレリ; iMF direct ブログ 2012年1月29日掲載
- 財政調整：過ぎたるは及ばざるがごとし?; カルロ・コッタレリ; iMF direct ブログ 2012年1月29日掲載 (Markdown version)
- 財政調整：過ぎたるは及ばざるがごとし?; カルロ・コッタレリ; iMF direct ブログ 2012年1月29日掲載 (PDF)