Resolutions for the Fiscal New Year—Staying on Track Is No Easy Task

IMF Blog, February 4, 2013

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One month into 2013, many private New Year resolutions have already been forgotten; fiscal resolutions in advanced economies have largely been kept.
The article compares typical personal resolutions (e.g., achieving a healthier weight) with countries’ commitments to fiscal deficit reduction, arguing that keeping fiscal commitments is difficult but essential.

The average headline deficit in advanced economies fell by about ¾ percent of GDP in 2012.
Cumulative deficit decline since budget shortfalls peaked in 2009 is 3 percent of GDP.
In some advanced economies:
- Debt ratios have begun to decline.
- In several others, debt ratios have stabilized.
In another group of countries (including some very large economies):
- Debt ratios are continuing to rise rapidly or have stabilized at very elevated levels.
- These countries will need significant deficit reduction in coming years to return debt ratios to more sustainable levels.
The United States and Japan are specifically identified as needing credible medium-term plans to restore public finances.
The United States must resolve to increase the debt ceiling expeditiously (and not just for a few months).

The impact of deficit reductions on growth depends on the design and timing of fiscal adjustment policies.
Under normal circumstances, a $1 cut in government spending typically reduces output by less than $1 because resources shift from public to private production.
With a weak private sector:
- Cuts in government spending are not partially offset by higher household and firm spending.
With interest rates in many advanced economies close to zero:
- There is limited scope for central banks to offset fiscal tightening by loosening monetary policy.
Therefore, countries that can afford gradual adjustment should avoid excessive front-loading of fiscal consolidation now.
As private sector balance sheets mend and banks recover lending capacity:
- Private demand should pick up and partially replace lower government demand.
- This replacement requires monetary conditions to remain relaxed for a long time—consistent with recent Fed guidance and advice for other central banks.

Countries that need to tighten policy should:
- Resolve to reduce fiscal deficits in a gradual and steady manner.
- Avoid excessive front-loading of consolidation.
- Commit to credible medium-term plans rather than postponing adjustment entirely.
Specific national recommendations:
- The United States: increase the debt ceiling expeditiously (and not just for a few months).
- Japan: adopt and begin enacting credible medium-term plans to restore public finances, especially given recent short-term fiscal stimulus.
For countries with Fund-supported adjustment programs:
- Allow for revised fiscal targets in response to slow growth to achieve a more gradual pace of consolidation (examples given: Ireland and Portugal).

Gradual but steady progress is the safest and surest approach to restoring fiscal health.
Maintaining credible, medium-term commitments is essential for returning public debt to safer levels and for ensuring that consolidation does not unduly harm growth.

Carlo Cottarelli, Philip Gerson — February 4, 2013