In late 2012 or early 2013 the U.S. federal government will again reach a statutory borrowing limit and will not be able to issue additional debt. Why is this a problem? First, because the federal government is spending considerably more than it collects in taxes; and second, because spending and tax collections are not synchronized. As a result, if the ceiling is not raised in time, the government would need to cut spending drastically, curtailing important government functions, with detrimental effects on output and employment. And just the mere possibility that the government might have to delay a payment on a bond could unsettle financial markets.
Four years later, Latvia has one of the highest growth rates in Europe, the peg has held, and the fiscal and current accounts are close to balance. Preparing for the conference I just attended in Riga in which we tried to draw lessons, and reading the evidence, I could think of seven reasons.
Going forward, while the space for a macroeconomic policy response is smaller than it was entering the global financial crisis, Asia’s policymakers still have ample room to react appropriately to a sharp deleveraging of foreign banks arising from a euro area shock. In addition, capital adequacy ratios, which exceed regulatory norms in most economies, and low nonperforming loan ratios, combined with room to offer liquidity support, suggest that relatively healthy local banking systems should also provide a buffer, as they did in the wake of the global financial crisis.
The Baltic country of Latvia has gone through the most extreme boom-bust cycle in emerging Europe, and was among the first countries to ask for financial assistance from the international community. Today, it is one of the fastest growing economies in the European Union. Real GDP grew by 5½ percent in 2011, and is now projected to expand by 3½ percent in 2012, a number that possibly will come out even higher. Latvia has also successfully returned to international capital markets.
Sub-Saharan Africa's solid growth record has been supported by several factors, including significantly less civil conflict, the generally favorable commodity price developments benefiting Africa’s natural resource exporters; and the extensive debt relief provided to most highly-indebted poor countries. But I would ascribe key importance to sound policy choices by African governments – both in terms of pursuing appropriate macroeconomic policies and pressing ahead with important reform measures.
The debate on austerity vs. growth has gained in intensity, as countries in Europe and elsewhere struggle with low growth, high debt, and rising unemployment. In essence, policymakers are being asked to tackle a continuation of the worst crisis since the Great Depression. This would be no easy task under any circumstances. But it is made considerably harder by the fact that a number of countries need to engage in fiscal consolidation simultaneously. Complicating the picture further is the fact that monetary policy in most advanced economies is approaching the limits of what it technically can do to stimulate activity, while global growth remains weak.
The crisis has harmed growth, increased unemployment, and left a large number of people less protected. We are now seeing some signs of stabilization. Most countries are reducing their deficits and even if debt ratios are still rising, the return back to fiscal health has begun.
Five years after the onset of the Great Recession, 16 million more people are likely to remain unemployed this year than in 2007. This estimate is for a set of countries for which the IMF forecasts unemployment rates; adding in some countries for which the International Labour Organization provides forecasts only boosts the number. The bulk of this increase in unemployed people has been in the so-called advanced economies (the IMF’s term for countries with high per capita incomes).
The fact is, the global outlook underpins any turnaround in Asia and at this point, it could go either way: too early to declare victory over the forces of financial volatility and contagion. The art then is being prepared for either eventuality and policymakers should be ready to shift gears if, and when, circumstances warrant.
We have calculated that an increase in annual long-term economic growth of just a quarter of a percentage point could set in place a virtuous circle that would lead, after ten years, to a decline in the public debt-to-GDP ratio by 6 percentage points. This is because higher growth makes it easier to run a primary surplus and lowers the public debt-to-GDP ratio directly. This in turn lowers the interest rate, which in turn boosts economic growth.