The Global Fiscal Outlook and the European Debt Crisis

Tuesday, March 19

Presenters
Carlo Cottarelli, Director of the IMF’s Fiscal Affairs Department
Aasim Husain, Deputy Director of the IMF’s European Department
Harald Waiglein, Director General for Economic Policy and Financial Markets at the Austrian Federal Ministry of Finance

Summary

On March 19, 2013, the Joint Vienna Institute (JVI) hosted high-level outreach event. Mr. Carlo Cottarelli, Director of the IMF’s Fiscal Affairs Department, and Mr. Aasim Husain, Deputy Director of the IMF’s European Department, presented the IMF’s views on “The Global Fiscal Outlook and the European Debt Crisis”. The event that took place a few days after the Eurogroup meeting on Cyprus was introduced and chaired by Mr. Harald Waiglein, Director General for Economic Policy and Financial Markets at the Austrian Federal Ministry of Finance.

In his opening remarks, Mr. Waiglein, who had participated in the Eurogroup meeting on Cyprus, briefed the audience on the most recent developments. During long discussions lasting into the night all those involved had been searching for a sustainable solution of the crisis with appropriate burden sharing.  

Mr. Cottarelli surveyed the public debt landscape in advanced economies, noting that the fiscal accounts in many advanced countries were in their weakest state in history. He divided the advanced countries into three groups: (1) countries where debt has stopped rising or was declining (Korea, Germany, Switzerland, Finland, Sweden, Czech Republic, Denmark); (2) countries where debt was still rising but was fairly low (Australia, Austria, Netherlands, Canada, Slovak Republic, New Zealand, Estonia); (3) countries where debt was still rising and was high, and thus faced more difficult fiscal challenges (Greece, Italy, United Kingdom, Japan, France, Portugal, Ireland, Belgium, Spain, United States). The current fiscal situation was largely the result of the global financial crisis, which had lowered growth trajectories and worsened fiscal balances. Looking ahead, Mr. Cottarelli recognized that “it will take decades to lower public debt to where it was before the crisis or, in any case, to levels that do not expose countries to risk.” He concluded, however, that “the task is not impossible; what is critical is to ensure that the direction of the adjustment is clear and that the adjustment process is perceived as credible.” According to Mr. Cottarelli, a credible adjustment process, he stressed, requires (1) a clear medium-term fiscal plan and strong fiscal institutions; (2) an appropriate pace of fiscal adjustment; (3) the right mix of revenue and expenditure measures; and (4) a relaxed monetary policy stance while fiscal adjustment is ongoing.

Mr. Husain considered the challenge of reconciling the recent improvement in market sentiment with the more downbeat data on the real economy. He emphasized that some countries in the euro area suffer not only from over-extended government and bank balance sheets, but also from over-extended household and corporate balance sheets. While the type of financial stress—whether for households, corporates or banks—differs from country to country, it is sufficiently large to be a drag on domestic demand. Such balance sheet considerations argue for a more nuanced policy response that allows balance sheets to adjust but with minimum output and job losses. Mr. Husain noted that at the country level, fiscal policy should focus on long-term measures to raise cyclically adjusted balances, combined with structural supply-side reforms to offset some of the output cost of depressed demand.  At the EU level, the most pressing task is to translate expansionary monetary policy into lower lending rates and easier credit conditions. Mr. Husain added that “a faster move to a banking union is essential, and policymakers will need to make progress on the broader reform of the European Monetary Union’s architecture, including fiscal union and—more urgently—the use of the European Stability Mechanism for direct recapitalization of banks.”

The presentations were followed by a lively discussion with the audience. The main issues raised included: the role of financial repression in bringing down the post-war public debt overhangs during the Bretton Woods system and the impossibility to rely on such policies in today’s world with complex financial systems; the effects of a possibly overvalued Euro for  the Euro Area periphery; the reasons for the relatively favorable position of the health and pension systems in Italy; difficulties in running countercyclical fiscal policies and bringing down public debt in good times; and the role of various factors in explaining the size of fiscal multipliers.

Martin Schindler, Senior Economist

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