The 2008–09 global economic crisis pushed public debt ratios of advanced economies to levels never seen before during peacetime. These high debt levels expose countries to a loss of market confidence and, ultimately, damage long-term growth prospects. Since 2010 advanced economies have been on a journey: the goal is to bring their public finances back to safer territory. They are in it for the long haul, not a sprint, and, as a redress of the large fiscal imbalances created by the crisis, without derailing the still fragile economic recovery, it requires a steady and gradual pace of adjustment—at least for countries not subject to market pressures.
This year we see the process of gradual fiscal adjustment reaching two symbolic milestones. First, 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. Second, the average debt ratio will stop rising, after increasing steadily since 2007. Indeed, it will actually decline slightly.
An uphill climb
Of course, at over 4½ percent of GDP the average deficit is still high, and stabilizing the public debt-to-GDP ratio, on average, at some 110 percent of GDP may not seem like much of an achievement. But these achievements should not be underestimated.
First, this result occurred despite countries experiencing extended slow growth. The lower growth obscures some of the impact of fiscal adjustment on the budget, as cyclical factors temporarily inflate deficit and debt-to-GDP ratios. Second, halving the deficit does not mean reaching the halfway point of the journey. In fact, most advanced economies are past that point, as the endpoint for most of them is not a balanced budget. Those that already have a fairly low debt level can do just fine with small deficits in the medium term.
Reaching the current milestone has not been easy: we cannot deny that fiscal adjustment has slowed the economic recovery and growth, and contributed to keeping unemployment rates at high levels. Indeed these adjustment hardships have taken a toll on many, and fatigue is emerging in some countries.
Leaving aside a few relatively small countries, 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. These countries still have gross debt ratios exceeding 90 percent of GDP and rising, although at different speeds. The good news about this group is that it has only 10 members; the bad news is that they represent about 40 percent of world GDP. So their fiscal policy is very important for the entire world.
It’s worth noting in this respect that they are not all equally distant from attaining fiscal health. The Fiscal Monitor revises the calculation of the fiscal adjustment needed to lower public debt ratios to more manageable levels over the longer run.
France and Belgium still have some way to go in terms of adjustment, but are not too far from the target balance. The others have more challenging tasks, with Japan being clearly an outlier in terms of both the magnitude of the adjustment needed and the level at which the primary balance would have to be maintained over the longer run. Italy is in a unique position: it is close to achieving a primary balance (revenue minus non-interest expenditure) that will put its debt ratio decisively on a downward path over time; but this level is quite high—indeed the second highest after Japan.
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. How does this compare with what countries achieved in the past?
The Fiscal Monitor provides some useful data. It looks at the largest primary balance ever maintained by advanced economies over a period of ten years and finds that the median of the distribution of these primary balances is about 3¼ percent of GDP—therefore below the above-mentioned range, but not by a huge amount. In addition, in the past the need to maintain large primary balances was smaller because public debt was much smaller.
So the task of lowering debt ratios to more suitable levels by achieving and then maintaining high primary surpluses is clearly feasible. But by no means will it be easy. Are there any shortcuts countries could take? Unfortunately, there are no easy alternatives. The inflation tax would probably require quite high inflation rates to have a major impact on public debt ratios. And 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.
Altogether the IMF’s advice remains: don’t give up, continue moving at a steady pace. And while on your journey, keep hydrated with plenty of liquidity. In other words, maintain relaxed monetary conditions: it will be good for the economy; it will be good for the fiscal account; and it will not harm monetary credibility if it is not seen as a replacement for fiscal adjustment but as a complement.
Are countries following this advice in 2013? Broadly, yes. Taking into account the size of existing imbalances and financing constraints, fiscal adjustment is proceeding in advanced economies at an appropriate pace, with some exceptions: on the one hand, Japan is moving too slowly: the stimulus package will keep the deficit close to 10 percent of GDP, which raises medium-term fiscal risks in the country. On the other hand, the adjustment is a bit too fast in the United States—where the deficit is projected to fall at the fastest pace in three decades. Moreover, some advanced economies in which private demand has been chronically disappointing should consider smoothing the pace of consolidation if they have the fiscal policy room to do so.