Prepare for belt-tightening, IMF warns

Governments should make clear to citizens that return to prudent policies is necessary

Reuters
22 March 2010

Developed countries with big budget deficits must start now to prepare public opinion for the belt-tightening that will be needed starting next year, the No 2 official at the International Monetary Fund (IMF) said yesterday.

John Lipsky, the Fund’s first deputy managing director, said that the scale of the adjustment required was so vast that it would have to come through less-generous health and pension benefits, spending cuts and increased tax revenues.

‘Addressing this fiscal challenge is a key near- term priority, as concerns about fiscal sustainability could undermine confidence in the economic recovery,’ Mr. Lipsky told the China Development Forum.

‘Already in several countries with particularly high debt and deficits, sovereign risk premia have risen sharply, imposing strains for the countries affected and raising risks of possible broader spillovers,’ he said in remarks prepared for delivery to the conference.

For most advanced economies, maintaining fiscal stimulus in 2010 remains appropriate, but consolidation should begin next year if the global economic recovery remains on track.

First, policymakers should already be making it clear to their citizens why a return to prudent policies is a necessary condition for sustained economic health, Mr. Lipsky said.

The IMF estimated that, by raising real interest rates, maintaining public debt at its post-crisis levels could reduce potential growth in advanced economies by as much as half a percentage point annually.

Second, fiscal institutions must be strengthened to withstand adjustment fatigue. Options include reinforcing fiscal responsibility legislation and improving tax collection. Third, entitlement reforms such as increases in the retirement age would have favourable long-term fiscal effects but do little near-term damage to aggregate demand, Mr. Lipsky said.

He painted a daunting picture of the tightening needed to restore public finances to health.

Gross general government debt in the advanced economies will rise from an average of 75 per cent of gross domestic product (GDP) at end-2007 to 110 per cent of GDP at end-2014, even assuming that temporary, crisis-related stimulus steps are withdrawn in coming years.

Reducing the ratio to the pre-crisis average of 60 per cent by 2030 would require raising the structural primary balance – before interest payments – from a deficit of about 4 per cent of GDP in 2010 to a surplus of about 4 per cent of GDP in 2020 and keeping it at that level for the following decade.

‘This would by itself represent a huge effort but in fact, any primary surplus improvement in the coming years will have to be accomplished while swimming against the already rising tide of entitlement expenditures on healthcare and retirement.’ Moreover, unwinding the anti-crisis stimulus measures would contribute only 1.5 per cent of GDP to the fiscal adjustment.

‘Thus, just keeping debt ratios at a post-crisis level will require new policy action,’ Mr. Lipsky said.

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