Transcript

September 1, 2010
Washington, D.C.

ALISTAIR THOMSON: Good morning. I'm Alistair Thomson of the IMF's External Relations Department. Thank you for joining us. I'm at IMF Headquarters along with Carlo Cottarelli, the Director of the Fiscal Affairs Department; Jonathan Ostry, the Deputy Director of our Research Department; Atish Ghosh, also of our Research Department; and Paolo Mauro, of our Fiscal Affairs Department. I'll turn this over to Carlo in a few minutes for introductory remarks on the paper "Long-Term Trends in Public Finances in the G-7 Economies;" after that, Jonathan Ostry will introduce the paper on ”Fiscal Space;” and then Paolo Mauro will discuss the paper "Default in Today's Advanced Economies: Unnecessary, Undesirable and Unlikely."

MR. COTTARELLI: Thank you very much, Alistair. As you know, public debt as been rising quite rapidly as a result of the global crisis which started in 2008, particularly in advanced countries. The paper, "Long-Term Trends in Public Finances in the G-7 Economies" puts this increase into perspective, looking at developments in the last 60 years and in the future 60 years. There are several important conclusions.

First of all, it's clear that even before the crisis, public debt had reached record levels in the G-7. The main reason is that over the last decades public debt had been used as a sort of shock absorber, going up in bad times but not coming down or not coming down sufficiently in most of the G-7 in good times. The second point is the surge in public debt during the crisis is mostly due to a loss of revenues due to the recession, to the decline in output, and not to discretionary fiscal stimulus. Altogether one can say that the fiscal problems that the advanced countries' world is facing now is not so much due to how fiscal policy was managed during the crisis but rather, I would say, how it was mismanaged before the crisis, the fact that advanced countries entered the crisis with historically high levels of public debt.

The third point I want to make is this increase in public debt over the last few decades was also accompanied by a rise in the size of the state, in the size of governments. There was an increase in the spending-to-GDP ratio across virtually all of the G-7, which was particularly strong between the middle of the 1960s and the middle or the end of the 1980s. This was primarily driven by increased spending for two items: pensions and health care. This increase in pensions and health care that characterized the last few years will also characterize the next decades.

Without a major correction of these trends, the net debt-to-GDP ratio, which is projected at about 75 to 80 percent of GDP for the average of the advanced countries this year, would increase to something like 200 percent by 2030 and 440 percent by 2050, primarily driven by the increased spending for health care and pensions. This clearly is not a sustainable trend and that's why our paper also looks at some key implications for fiscal adjustment plans in the next few years and in the next decades.

The first point that the paper makes is stabilizing the debt-to-GDP ratio at new records levels will not be sufficient, that it is necessary to gradually bring public debt down. Again, public debt cannot go up. It's okay if it goes up in bad times, but it needs to come down in better times.

The second point is that adjustment plans would have to focus on controlling spending for health care and pensions, but this will not be sufficient as cuts in other spending will also be needed, and in countries with low tax rates it will also probably be necessary to increase taxation. Fiscal institutions and fiscal rules will also have to change with respect to the past. The fiscal institutions that prevailed in the last decades are those that permitted an excessive increase in public debt before the crisis.

The paper also makes the point that boosting potential growth is extremely important to facilitate the fiscal adjustments. It computes for example that a 1-percentage point increase in potential output would lower the debt-to-GDP ratio by 60 percentage points in 20 years even assuming that some of the revenues are spent. This is important because it underscores how important fiscal adjustment is to sustain the long-run growth process. This consideration also explains why we need some gradualism in tightening fiscal policy. A medium-term orientation rather than a quick fix is needed. Of course this does not mean that there should be no action now. Earlier we said in the op-ed that I wrote with [IMF chief economist] Olivier Blanchard that there is need for a sort of down payment for the fiscal adjustment. At the moment advanced countries are envisaging a fiscal adjustment of about 1 percentage point of GDP in 2011, which at present we regard as broadly consistent with the continuation of the recovery process. Of course these views will be updated and reconsidered in the forthcoming publications in the World Economic Outlook (WEO) in mid-October, about October 10, and the Fiscal Monitor in early November—and we are targeting November 3 for the issue of the next Fiscal Monitor. Thank you very much.

MR. THOMSON: Thank you, Carlo. Now we will go to Jonathan Ostry who will discuss the Fiscal Space paper.

MR. OSTRY: Good morning. A key issue confronting the global economy today concerns the degree to which countries have room for fiscal maneuver, fiscal space, and the extent to which adjustments in fiscal policies are necessary to achieve or maintain public debt sustainability. Financial markets have brought these concerns to the front pages and a more general reassessment of sovereign risk, given the fiscal legacy of the financial crisis, and the looming demographic pressures, remains a palpable threat to the global recovery. While debate has been intense in recent months on the fiscal challenges that lie ahead and how much room governments may have before markets force them to tighten policies sharply, talk about fiscal space, about how to measure the concept, and its policy implications, has been rather fuzzy.

The policy note we're releasing today aims to remedy this by doing two things. First, providing an operational definition of fiscal space, which we define as the difference between current debt and the level of indebtedness beyond which a country's debt becomes unsustainable based on its normal historical pattern of adjustment. And second, providing empirical estimates of available fiscal space for 23 advanced countries.

Given time constraints, I will not go through the numbers themselves. Suffice it to say that the main message from the empirical work is that advanced economies are not all in the same boat in terms of available fiscal space. Some have a lot, others have none, and a third group is in the middle. Fiscal space differs across countries for two reasons: different debt limits, where one size fits all does not apply given differing track records of adjustment; and varying current levels of debt. The paper contains the numbers.

Turning to the analysis, how did we approach the related issues of debt limits and fiscal space? Some of you may be thinking -– as other commentators have said --that debt limits are not a relevant concept for advanced economy sovereigns. After all, a sovereign's right to tax and not spend surely means that future changes in fiscal policy can always ensure that public debt is repaid. Our take is different, not least because markets will not be impressed by promises of change when a country has little or no track record of adjustment, words unsupported by deeds. For this reason, our analysis grounds the notion of fiscal solvency in the actual track record of countries, how policy responded in the past to changes in public debt. If governments were able to raise the primary budget balance, that is the balance net of interest payments, when public debt went up, then they at least had an implicit rule of making sure that debt would be repaid. As such, markets could take comfort that, in the very long run, the sovereign would honor its financial obligations.

But this finding of a positive response of the primary balance to rising debt can only be true up to a point. As debt grows, it becomes increasingly difficult, reflecting both economic and political realities, to improve the primary balance enough to offset higher debt service costs. Eventually there is a threshold, a debt limit, when debt simply gets too big, adjustment fatigue sets in, and the surplus cannot keep pace with rising debt repayments.

Of course, markets don't sit idly by as debt approaches its limit. Instead, they add a risk premium to the interest rate that they charge to sovereigns, reflecting the potential for default. And, by adding to the cost of debt, this higher risk premium means the country will be more likely to reach its debt limit. When concerns are acute, only policy adjustments that are dramatically different from past efforts will be enough to maintain capital market access.

What are the implications?

First, there is a definite wakeup call in the finding that a country has little or no fiscal space. In these cases, fiscal policy needs to break fundamentally from the past to credibly signal to markets that debt limits will not be reached. Business as usual simply won't cut it.

Second, a finding of little or no fiscal space does not imply that default is inevitable. Debt limits are not etched in stone. Our estimates of fiscal space are based on the assumption that future policy reactions will mirror those in the past. Since behavior can change, history is not destiny as long as policy changes credibly.

Third and finally, countries will generally want to target debt levels well below the limits. As pubic debt rises or views about fiscal risks or indeed the reliability of fiscal data change, our results imply that markets may give little or no warning about imminent spikes in borrowing costs or curtailed access to the debt markets. With the inevitable uncertainty around where precisely the debt limits lie, and the potential for market perceptions to change in the bat of an eye, there is a need for caution. A few successful auctions are not grounds for complacency.

Many of these points resonate with the experience of some Southern European countries in recent months and underscore the need to maintain a comfortable degree of fiscal space at all times. And if fiscal risks rise, there needs to be the political willingness, already evident in a number of countries, to undertake adjustment efforts that are extraordinary by historical standards, in a timely fashion, to sustain or to restore sustainability.

Thank you.

MR. THOMSON: Thank you, Jonathan. Finally to introduce the paper on default, Paolo Mauro.

MR. MAURO: Thank you, Alistair. This is Paolo Mauro from the IMF's Fiscal Affairs Department. Good morning again.

Let me briefly introduce the discussion of our paper, "Default in Today's Advanced Economies: Unnecessary, Undesirable and Unlikely." I hope at least the title makes it clear where we stand. The paper grew out of a sense of frustration over the past few months. Our frustration was that there was limited data analysis and lots of negative talk about the feasibility of fiscal adjustment in countries that market participants are focusing on. Much of the market commentary portrays default as inevitable. Auctions of government paper in Europe are followed with apprehension. And despite progress on fiscal adjustment, spreads in the European peripherals remain high. So we felt we had to bring more thorough evidence and analysis of fiscal data to bear on these important questions.

In a nutshell, our view is that markets are significantly overestimating the risk of default and the reasoning is this. Yes, the years ahead are going to be very difficult, the requisite fiscal adjustment is going to be extremely large but there are several historical precedents for such adjustments. More important, for countries currently experiencing market pressures, marginal rates of interest are high, but long maturity structures imply that average interest rates on the stock of government debt remain low, in fact considerably lower than they were for the emerging economies that defaulted over the last couple of decades. So the problem in the advanced economies today is the large primary deficit, not the interest bill as was the case for the emerging economy defaulters of the past. Thus, the needed fiscal adjustment would not be much lower even if a restructuring were undertaken with a large haircut.

Why? Suppose you default and thereby you reduce your interest bill. Then you still have to undertake a massive fiscal adjustment to reduce the primary deficit. In fact, you have to reduce it to zero immediately or even have to run a small primary surplus because by defaulting you get shut out of the markets and you can no longer borrow. Some commentators have a subtler argument. They say for a few years there will be fiscal adjustments, but as soon as you reach primary balance and you still have a large interest bill, then at that point that's when default becomes irresistible. However, several advanced economies found themselves exactly in that situation and none chose to default. Once countries incur the initial pain of adjustment, they persevere and go to great lengths to avoid default.

We present further arguments and analysis in the paper, but in the interest of time let me stop here and solicit any questions that you may have.

MR. THOMSON: Thank you, Paolo. I think we can now ask the participants to pose their questions.

QUESTIONER: Good morning. I have a question on debt limits. You are talking about a kind of Greek scenario when interest rates are going up suddenly, and we all know the story in Greece. It was that there was a new government coming and they said that the deficit was much higher than what had been initially estimated. What kind of shocks would you expect to produce the same result if it's not the new assessment of the figures?

MR. OSTRY: Thank you. I think you're right, the Greek case does show that revisions to the data can lead to a rapidly changing market environment for the sovereign. The other thing that could drive such a shift is some new perception about the magnitude of possible fiscal shocks, what we call the support of the shock to the primary balance. So, historically, in our sample, the size of the support seems to be of the order of 5 percent of GDP. But suppose some country has typically incurred shocks to its primary balance that are a fraction of that, only a couple percent of GDP, and one day it wakes up to the need to recapitalize massively its financial sector, and it incurs thereby a massive shock to its primary balance, this could in turn unnerve markets. In particular, if the country is within a distance to its debt limit of the support of the fiscal shock, then it could go from a situation in which it enjoys free and full access to the capital markets to a situation in which it is virtually shut out. In those circumstances it's very important, and indeed long before that, to undertake policy measures that keep you well away from the debt limit, and thereby increase your insurance against potential revisions by market participants of the possible size of the support to your fiscal policy shocks.

QUESTIONER: I found what I would call an inconsistency between the paper on the debt limit and the paper on why countries won't default. The sort of common sense of the debt limit as I understand it, the reason you want to avoid that debt limit, is because essentially country A, the threat is that it will default and so the market will punish it with much higher interest rates.

On the other hand, you’re saying well, don’t worry, countries really don’t default. And as I say, there are sort of two, to me, very different and contradictory messages there. Can you, either of you or both of you, address that?

MR. COTTARELLI: Hi, Bob. It’s a good question in many respects. What we really say is that markets are currently overestimating the risk of default. Of course, there is always the possibility that something happens. But what we are saying is that the probability of default is largely overestimated. This is not in contradiction at all with the fact that some of the countries may be close to that limit. As Jonathan described before, being close to the limit means that you need to change your behavior with respect to the past. And what we are saying is that for the countries that we are looking at, it is possible to change this behavior and especially that the problem is not so much the public debt and the interest payments which could elicit a response in terms of debt restructuring. But the main problem is the primary deficit, and the primary deficit needs to be adjusted regardless of the level of public debt.

We have already seen—and this is also important to underscore—some of the countries are already changing their behavior, and that’s why we say tour paper reflects our sense of frustration. When the idea of this paper came out a few months ago, I was in Europe talking to financial market analysts. And I think the sense that I got was that the reaction of the market was in some respects not completely rational in the sense that there was little thought in looking at the numbers, but was more a feeling, a sensation, that things were going badly and would continue to go badly. We are seeing that policy reaction is taking place, and so I think that there is evidence that countries are reacting in the orthodox way by adjusting the primary balance. I don’t know whether Jonathan wants to add anything on this.

MR. OSTRY: I don’t have much to add, just in a nutshell to underscore what Carlo says and what the fiscal space paper says. The need to act is basically premised on the idea that you can only really increase your fiscal space by credibly signaling to markets that you are departing from the fiscal behavior of the past that got you to the debt levels that you had. So the debt limit is a function of your historical pattern of adjustment. When debt goes up, did you respond vigorously by raising your primary balance? Just like if you’re an individual and you want to top up your loan from a bank, the bank is going to want to be convinced that you will generate the saving as an individual that will enable it to see its debt repaid rather than get into a kind of ever-greening or a Ponzi scheme-type of situation. So you need to credibly break from the past. The debt limit is not etched in stone, but you need to credibly signal that you’re not engaging in a business-as-usual type of fiscal policy.

QUESTIONER: Can I ask as a follow up, just on Greece in particular—I mean, my sense from talking to people in the market was generally speaking—and obviously people have different opinions—generally speaking, the view was that the IMF program had bought them a few years. Eventually they would default, but when they defaulted in three years or whatever it would be, the global economy would have been in a much better situation to handle it. Markets would have been warned, you know, in advance that they’re going to have to take a haircut, and so it wouldn’t be that big a deal. And the paper here argues that that’s misguided, that sort of view is misguided. Is that right?

MR. COTTARELLI: Well, as I said, I think the markets are overestimating the likelihood, largely overestimating the likelihood, of this scenario that you are describing. The adjustment in Greece is taking place, and it’s front-loaded. So it’s already happening, it’s not just promises. Of course, in my view, it’s going to take some time before markets are fully convinced about this. But again, as you said, the program supported by the IMF and the European Union has bought the time for Greece to implement this adjustment. So our view is that the markets will realize this at one point, and that they are currently overestimating the risk of the kind of scenario that you described. Once again, even now, the interest rates on average that Greece and the other countries are paying is well below the interest rate that countries that had to default were paying at the time of default. And why is this so? Because the advanced countries entered the crisis with a long maturity of public debt. And as a result, this high marginal interest rate that these countries have been paying in the last few months has not yet impacted the average cost of public debt, which is what matters for public sustainability, for fiscal sustainability.

QUESTIONER: I just wanted to make sure we’re clear on how to interpret this chart, the red and yellow chart on the fiscal space paper. We’ve got some probabilities it looks like, and I just wondered—so with the case of the U.S. say, explain this to me in layman’s terms. What does it mean?

MR. OSTRY What the numbers for the U.S. mean is if you look at the first column, the heading of which is “FS>0,” which is “the fiscal space is greater than zero,” it’s saying that with the projected market interest rates, there’s a little over a 70 percent chance that the U.S. has positive fiscal space, i.e., that it’s away from its debt limit. Likewise it’s saying if you want—if you’re interested not in whether it’s an inch away from its debt limit, but whether it has at least 50 percent of GDP of fiscal space, i.e., it’s at least 50 percent of GDP away from its debt limit, it has about even odds, 50 percent chance --

QUESTIONER: Okay, so 50-50 that we’re 50 percent away—50 percent of GDP away from the limit, from the wall?

MR. OSTRY: Exactly. And then likewise, if you want to be 100 percent away from your limit, there’s very little chance that that’s the case. And you’re very likely to be less than 100 percent of GDP away from your debt limit. And then the second set of numbers are basically the same calculations but with the interest rate that’s generated by the model rather than the WEO projections.

QUESTIONER: I see. So just to put that in dollar terms, there’s a 50-50 chance that the U.S. could borrow $650 billion or whatever that is --

MR. OSTRY: Whatever GDP is --

QUESTIONER: $650 trillion or whatever, okay. Fine.

MR. OSTRY: It’s a big number.

QUESTIONER: Yeah, it’s a big number. So you think they are—it is essentially saying the U.S. is okay. Some others are not so okay, the ones in red?

MR. OSTRY: On “okay,” I think the message is—remember the debt limit is the point from which basically you bounce off to infinity. So it’s a point really that you want to strenuously avoid. And while it may seem that, you know, you’re just oodles and oodles away from this point, you know, there are always things that you need to keep in mind including, the demographic pressures. I mean, think of the beauty of, or the curse of, compounding here. If health care spending, because of demographic pressures, needs to rise over the next few decades by 5 to 10 percent of GDP, which does not seem completely outlandish, then the debt, if you add that over a ten-year period, is going to rise, other things being equal, ten times as much.

Likewise, if we’re wrong about our estimates of what the primary balance that the U.S. can generate in a sustainable way over the medium term is by, say, only 1 percent of GDP, you compound that, you divide by the growth-adjusted interest rate—suppose that’s on the order of 1 percent--you can be off on the debt limit by a large amount. So I just underscore that, some commentators have focused on the fact that our numbers are very large, and other people who talk about what debt targets should be for industrial or emerging-market countries, the numbers they bandy around are on the order of 60 or 90 or 40 percent of GDP. Our numbers are much larger, but remember, they’re not conceptually the same thing. Ours is a point really of no return. This is a point that you want to be well, well away from—given also the fact that markets typically give you very little warning of when you’re about to get into trouble.,

QUESTIONER: Well, let me just to follow up—that sort of gets to what I wanted to ask. I mean, how useful is this really, other than as an intellectual exercise, since you don’t know where that point is until the market decides you’ve hit it?

MR. OSTRY: I think there’s at least one way that I can think of answering your question. I mean, the paper presents both point estimates and probabilistic estimates. The colored picture that you talk about with yellows and reds gives you an idea of the probabilities of how uncertain we are about our point estimates. And I think, you know, to me it’s a much too weak objective to be content with saying “Well, as long as I’ve got some positive fiscal space, the high probability of some positive fiscal space, I’m out of the woods.” To me you want to maintain a considerable degree of fiscal space, something on the order of 50 percent of GDP, and you want to sort of buy some insurance of continually being well away from the debt limit. So I’m not saying, you know, that there’s sort of a panic in any of these countries if some of these numbers are red or yellow, but I’m saying that you want to credibly signal to markets that you are not going to use up the buffers that are in place today.

QUESTIONER: Hi, yes, thanks for taking my question. Following up just on that last question, to what degree are these calculations something countries can use as a guideline or a benchmark to sort of, you know, build their fiscal policy? And are you considering using this in the Article IV Consultations as something that will be rated or evaluated?

MR. OSTRY: Well, this is in part an intellectual exercise, let’s be honest about that. We have a whole bunch of internal mechanisms to help guide our surveillance and our policy advice with countries. As you may know, we have a vulnerabilities exercise for both advanced and emerging-market countries. We have an early warning exercise where we report to our governing body, the IMFC (International Monetary and Financial Committee), twice a year on what we consider to be the key tail risks for the global economy. And we have the annual consultation cycles with all of our member countries where we discuss the whole gamut of policies, including fiscal policy, and to the degree that the teams working on these various exercises find the approach taken in this policy note to be of help, it could be an input into that process.

QUESTIONER: But you haven’t had that discussion yet as to whether it will be or whether that was part of the intention?

MR. OSTRY: Correct. We haven’t had that discussion yet.

QUESTIONER: And if I could just follow up. You mention that some countries, both the default risk and the fiscal space together, so if either of you would like to answer, that some countries have already started to move. Carlo mentioned that even Greece is, you know, adjustment is front-loaded. But are you satisfied that enough of the industrial countries that need to make changes have started to do so or signaled that they will, or are there a significant number of those that need to move more quickly?

MR. COTTARELLI: The position that we have taken in our most recent presentations of this is that at the moment we see that what countries are doing, broadly speaking, is fine. And for next year, the advanced countries on average are envisaging an improvement in the cyclically adjusted deficit by about 1 percent of GDP. Further information for the discussion would be in the WEO and in the Fiscal Monitor. This is regarded to be consistent with the recovery. We also believe that broadly speaking their medium-term plans are appropriate. What is still missing, however, is the fact that the measures, the policies behind these medium-term plans, have not yet been fully identified, and that—and this is related—a lot remains to be done over the next few years to control the pressures from pension spending and health care spending.

For pension spending, we project an increase over the next 20 years in the spending-to-GDP ratio that is relatively contained, 1 percentage point of GDP for the average of the advanced countries because a lot of reforms have already been implemented in this area. Without reforms the increase would be 3 percent points of GDP over the next 20 years. Because of the reforms, the increase is 1 percentage point of GDP. The area where more remains to be done is health care. We project spending for health care to increase over the next 20 years in—in the G-20 advanced countries—by about 3.5 percentage points of GDP, a bit more in the United States, a bit less in Europe. But this is one area where more needs to be done.

QUESTIONER: In the paper on the G-7 public finances, you mention the need for a more energetic fight against tax evasion. You moot the idea of a world tax organization to coordinate this. Is this a new suggestion from the IMF, or have you held this position for a while? And also, have you any more ideas of how such an organization might work?

MR. COTTARELLI: First of all, let me clarify that these views that are put forward in staff position notes do not reflect the view of the institution. These are the views of the staff who wrote the papers.

This is not, certainly, a new view. I think we quote in our paper the fact that Vito Tanzi, who was Director of the Fiscal Affairs Department during the ‘80s and the ‘90s, also suggested the need for some form of coordination. Obviously, the creation of a world tax organization is a very difficult step and in a way it is a provocative proposal. What I think is less provocative and more concrete is the need for more discussions, coordination, in tax policy because it is clear that there are major spillovers in tax policies across countries.

QUESTIONER: Thank you very much. I understand that Mr. Tanzi had suggested that in the late ’80s and ‘90s, but the OECD (Organization for Economic Cooperation and Development) I think took up the battle in the early 2000s and this, as far as I can see, is the first time anyone from the IMF has mentioned it in the recent past. Is that—is my assumption correct?

MR. COTTARELLI: Yes, I mean, you know, in the recent past Vito Tanzi was the head of the Fiscal Affairs Department until 2000 and so it’s not such a long time ago. But as I said, we wanted to be provocative to stimulate the discussion on the need for more tax coordination rather than just proposing this as the only possible solution.

QUESTIONER: Hi. Jonathan, your [earlier] answer kind of confused me, and I realized I couldn’t read these charts so just one more time on that one. FS is greater than zero—does that mean it has hit the debt limit? I mean, if you look at Japan, it’s, you know, across the line. It’s essentially zero. So does that mean Japan has reached its debt limit? But clearly Japan can still borrow, so what does, you know, what—what does FS more than one mean and using Japan as an example, what’s the message to Japan?

MR. OSTRY: Okay. Thanks. Jonathan, here. So let’s recap on the U.S. and then I’ll turn right away to Japan. The U.S.’s probability that fiscal space is positive is around 70 percent; probability that it’s greater than 50 percent of GDP, about 50-50; and probability that it’s greater than 100 percent of GDP, very small.

QUESTIONER: And positive means it can borrow anything or borrow --

MR. OSTRY: Positive means, the probability that current debt is below the debt limit. So “fiscal space is positive” means current debt or projected debt is below the debt limit.

QUESTIONER: Right.

MR. OSTRY: So, yes, it can be either borrowing at a risk-free rate, which is basically the case of the U.S., or at a risky but finite rate, which could be the case for some other countries that are somewhat closer to their debt limit.

Now the Japanese case is a very interesting case. What we find—and this isn’t rocket science—if you simply plot out over our sample the debt-to-GDP ratio of Japan, you will find that it rises over the entire sample. And Japan has not been running primary surpluses; it’s been running primary deficits. Now a key part of sustainability is that in response to an increment to debt, you raise your primary balance. So Japan has not been behaving over this sample in a way that satisfies this definition of solvency. Now you raise the question, “How come markets have not shut Japan out from being able to borrow?” And indeed, Japanese interest rates as you know are incredibly low. Well, I mean, there’s been a lot written about these issues and the puzzles and people have talked about the fact that much of the debt is held domestically—the lenders are domestic—and so the discipline from foreign lenders is not there.

There’s the high saving rate and the fact that this pool of savings is almost like a captive source of financing for the government. And likewise, there have also been people who have commented that this cannot go on forever, and of course, that’s right. The aging of the population will eventually diminish the pool of savings. So our paper cannot say what the time dimension is for this change—and it’s quite likely to be gradual rather than sudden—but certainly in terms of a very standard, common, definition of sustainability, Japanese fiscal policy does not satisfy that over the sample that we considered.

MR. THOMSON: Thanks very much. This is Alistair. If there is one more question, we could probably take that, then I think we’re going to have to wrap up the call. Are there any more questions waiting?

QUESTIONER: Yes. Good afternoon. And my question in a way is a reverse of the first question when it was asked about negative shocks and the impact on public finances. And I would like to ask what sort of positive shock is needed to normalize the situation of spreads, what you call, the over valuation of risk and the perception of risk because clearly in the case of Greece, for instance, not even the IMF yield package was the positive shock that was enough to normalize the situation nor was the announcement of large fiscal packages in, for instance, Portugal or Ireland. So do you think it’s just a matter of time? I guess you hope that your contributions here today will also sort of encourage this correction in the perception of risk, but I guess—is there a positive shock that is needed or necessary? Where will it come from?

MR. COTTARELLI: Hi, this is Carlo. Well, essentially, what we say is a bit what you’re saying, that it takes some time. You may remember that in early 2009 markets were—we were surprised by the fact, and in spite of the deterioration in the fiscal accounts, the market was still optimistic about most of the countries—we would say all of the countries initially—all of the advanced countries. And what we are seeing now is the opposite, that there is too much pessimism. You’re asking what could be the positive shock? You’re right. Sometimes it takes just a positive shock, but sometimes it’s just a realization that things continue gradually to improve. And I think that even in the absence of a positive shock, you’re going to see the realization that things are not as bad as markets are currently envisaging. And this fear—essentially what we see now really reading in the reports from the markets—every single action in Europe is seen as a possible trigger of something bad. And I think this is just too pessimistic.

The IMF would like to show that if you look at the data, the current cost, the amortized cost of borrowing and that the fact that the problem is with the primary, I think that by encouraging a more rational approach to look at numbers, I think we will come to the conclusion the current risk of default is overestimated in Europe.

MR. OSTRY: I’d just briefly add, that what Carlo says, that it would take time, makes perfect sense. If you’ve been behaving, as Carlo said in his introductory remarks, in a way in good times that is not in the direction of satisfying your solvency constraint, then if you change course, it’s not surprising that markets will take a little bit of time to absorb that and decide that this is a credible structural change in policy rather than a quick fix while the eyes are on you, and then you revert back to your old ways when markets have forgotten again. So it makes sense that it could take some time.

MR. THOMSON: Thank you, Jonathan. I’m afraid that’s all we’ve got time for in terms of questions. If you do have urgent questions that you have not had time to put, please do follow up with me by e-mail.

I want to also thank Carlo Cottarelli, Jonathan Ostry, Atish Ghosh and Paolo Mauro who took part in this call, and of course, all of the reporters who’ve dialed in. I wish you good day. Thank you.