The Fiscal Milestone: Achievements, Fatigue, and Prospects

IMF Blog, April 16, 2013

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Author: Carlo Cottarelli
Date: April 16, 2013
Theme: Advanced economies’ multi-year effort since 2010 to bring public finances back to safer territory after the 2008–09 global economic crisis.

Two symbolic milestones reached:
- The average deficit of advanced economies as a share of GDP will fall to half of its 2009 level at the peak of the crisis.
- The average debt ratio will stop rising after increasing steadily since 2007 and will actually decline slightly.
Caveats about the milestone:
- The average deficit remains high at over 4½ percent of GDP.
- The average public debt-to-GDP ratio is being stabilized, on average, at some 110 percent of GDP.
- These outcomes occurred despite extended slow growth, which temporarily inflates deficit and debt-to-GDP ratios because of cyclical factors.

Fiscal imbalances remain large in ten countries (the United States, Japan, the United Kingdom, and seven euro area members including France, Italy, Spain, Belgium, Portugal, Greece, and Ireland).
Characteristics of this group:
- Gross debt ratios exceeding 90 percent of GDP and rising (though at different speeds).
- The group represents about 40 percent of world GDP.
Impact of fiscal adjustment to date:
- Fiscal adjustment has slowed economic recovery and growth, and contributed to keeping unemployment rates at high levels.
- Fatigue is emerging in some countries because of adjustment hardships.

The Fiscal Monitor revises calculations of fiscal adjustment needed to lower public debt ratios over the longer run.
Country-specific notes:
- France and Belgium: still have some way to go but are not too far from the target balance.
- Japan: an outlier in both the magnitude of adjustment needed and the level at which the primary balance would have to be maintained.
- Italy: close to achieving a primary balance that will put its debt ratio decisively on a downward path, but that required level is quite high—the second highest after Japan.
Required primary balance for the group on average:
- The primary balance that this group of countries will have to maintain during 2020–30 (that is, gradually converging to this level) is in the 3¾–5¼ range, depending on interest rate and growth assumptions.
Historical comparison:
- The Fiscal Monitor finds that the largest primary balance ever maintained by advanced economies over a period of ten years has a median of about 3¼ percent of GDP—below the 3¾–5¼ range, but not by a huge amount.
- Historically, the need to maintain large primary balances was smaller because public debt was much smaller.

Shortcuts evaluated and dismissed:
- Inflation tax would probably require quite high inflation rates to have a major impact on public debt ratios.
- Taxing bondholders through debt restructuring is not much of an alternative to fiscal tightening given a large share of bonds is held domestically, particularly in many advanced economies.
IMF advice:
- Continue moving at a steady pace; do not give up.
- Maintain plentiful liquidity—i.e., relaxed monetary conditions—to support the economy and fiscal accounts.
- Ensure monetary policy is not seen as a replacement for fiscal adjustment but as a complement.

Broad characterization: advanced economies are, broadly, following the IMF’s advice on appropriate pace of fiscal adjustment, with exceptions.
Noted exceptions and concerns:
- Japan: moving too slowly; the stimulus package will keep the deficit close to 10 percent of GDP, which raises medium-term fiscal risks.
- United States: the adjustment is a bit too fast—the deficit is projected to fall at the fastest pace in three decades.
- Some advanced economies with chronically disappointing private demand should consider smoothing the pace of consolidation if they have fiscal policy room to do so.

Source: The Fiscal Milestone: Achievements, Fatigue, and Prospects (Carlo Cottarelli, April 16, 2013).

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