The International Monetary Fund released its latest Fiscal Monitor last week. As expected, the headline message was quite grim for the advanced economies, many of which face grueling fiscal adjustments in coming years.
One of the IMF’s most important findings is that the government financing needs of many advanced economies “remain exceptionally high.” As illustrated in the following chart, Japan will have to sell debt equivalent to 64% of GDP this year in order to rollover maturing debt (54% of GDP) and finance new deficits (10% of GDP):
The United States comes in second, needing to sell debt equivalent to 32% of GDP in order to rollover maturing debt (21% of GDP) and cover new deficits (11% of GDP).
Why does the USA come in ahead of more troubled economies such as the UK and the PIIGS? Because our debt has a much shorter average maturity. According to the IMF, the average maturity of US debt is only 4.4 years. Portugal, Italy, Ireland, and Spain have maturities that are about 50% greater (from 6.2 to 7.4 years), and the UK is almost three times as long at 12.8 years.
The short maturity of US debt is a blessing in the short run, since we can benefit from lower interest rates. But it is also poses two risks in the long-run: greater exposure to interest rate increases (if and when they materialize) and a relentless need to ask capital markets to rollover existing debts. Both good reasons why Treasury should continue to gradually extend the maturity of federal borrowing.
Greece needs money fast. The International Monetary Fund (IMF) and members of the Euro-zone have that money. But before they lend it to Greece (at very favorable interest rates), they are demanding that Greece get its fiscal house in order.
As a result, Greece is proposing an austerity plan that would reduce its out-of-control budget deficits (currently standing at more than 13% of GDP) by at least 10-11% of GDP.
You might wonder whether that’s possible. History suggests the answer is yes, at least in principle. Indeed, several countries have achieved even larger deficit reductions.
This list demonstrates that large-scale budget improvements are possible. But they don’t always stick. Sweden, for example, makes two appearances in the top nine. Its gains in the 1980s were undone in the financial crisis of the early 1990s, so it had to undertake a second round of austerity. And Greece itself is a repeat offender, as its gains from the early 1990s have all been lost.
Greece faces enormous practical and political challenges in its austerity efforts, and success is hardly guaranteed. The nation can take some encouragement, however, from the fact that other nations have addressed even larger budget holes.
With some hard work and luck, perhaps Greece will join Sweden as a two-time member of the Large Deficit Reduction Club.
Several colleagues recently suggested that now is a propitious time to read (or re-read) Paul Blustein’s “The Chastening.” The book recounts how the International Monetary Fund (IMF) and the G-7 nations struggled to combat the Asian, Russian, and Latin American economic crises of the late 1990s.
Having read the book while flying back and forth across the nation, I heartily agree. The Chastening is a great read if you want to get up to speed on many of the issues now posed by the “PIIGS” (Portugal, Ireland, Italy, Greece, and Spain).
I particularly enjoyed (if that’s the right word) the number of characters, familiar from today’s Greece debacle, that appear in the book. For example:
* The government that used derivatives to hide its perilous financial situation (Thailand)
* The German leaders who denounced the moral hazard created by sovereign bailouts (most notably Hans Tietmeyer)
* The policymakers facing doubts (often well-founded) about whether assistance packages could really help or were just postponing the inevitable (and, in the meantime, bailing out some unsympathetic creditors).
With the benefit of ten years more hindsight, readers can also enjoy a certain “you ain’t seen nothing yet” thrill from passages about how scary the financial world looked during the crises of the late 1990s.
[Alan Greenspan the] Fed chief told the G-7 that in almost 50 years of watching the U.S. economy, he had never witnessed anything like the drying up of markets in the previous days and weeks. (p. 334)
Unfortunately, we were all in for even worse in less than a decade. And now Greece is following in many of the steps of Korea, Thailand, Indonesia, Russia, and Brazil.
Now you might be wondering what a structural primary budget deficit is. Good question. The “primary” part means that the IMF excludes from the calculation any interest that governments are paying on their outstanding debts. That’s a useful thing to do if you want to focus on the programmatic spending and revenue decisions that governments are currently making. The “structural” part means that the IMF has tried to strip out the effects of the business cycle to identify the underlying posture of government policy. (Because of the weak economy, the IMF estimates that the U.S. primary deficit will be 8.1% of GDP in 2010, much higher than the 3.7% of GDP structural primary deficit.) And just to round out the details, you should also be aware that to make things comparable across countries, the IMF combines all levels of government together, so the U.S. figures include not only the federal government, but also the state and local governments.
With that context, the basic message of my first chart is that the United States has a very large structural primary deficit, but a few countries are even worse off: Japan (which has been running large deficits for years) and Ireland, the United Kingdom, and Spain (which had more severe credit booms and busts than we did, suggesting that the crisis had some structural effects, not just cyclical ones). At the other extreme, Norway is sitting pretty with its oil revenues.
The IMF also estimated how large a fiscal adjustment (i.e., spending reductions and tax increases) each economy would have to undertake to get their government debts back to a reasonable level. The basic idea is that, at a minimum, nations should run small primary surpluses and, in addition, some (including the United States) may need to reduce the size of their debts relative to the economy. Using a quite ambitious debt target (60% of GDP for the gross government debt for most countries), the IMF projects the following adjustments would be necessary:
If you take these results at face value, they suggest that the United States will have to cut spending and increase revenues by a combined 8.8% of GDP between 2010 and 2020, a fiscal adjustment of around 0.9% per year. Imagine having to enact a permanent spending reduction or tax increase of $120 billion per year next year, and then do it again in each of the next nine years. Rather daunting.
One can, of course, quibble with the specific assumptions that IMF has used. For example, getting the gross government debt down to 60% of GDP (about where it was before the financial crisis) may be a bridge too far. But clearly the United States will have a lot of work to do. But hey, things could be worse. We could be Spain, Ireland, the UK, or Japan.
The global financial crisis is likely to leave long-lasting scars on the world economy, but governments can act to stimulate a quicker revival and counter output losses … . The study finds that banking crises typically have a long-lasting impact on the level of output, although growth eventually recovers. Lower employment, investment, and productivity all contribute to sustained output losses.
Those conclusions are based on their review of financial crises around the world since the early 1970s. As shown in the following graph, the key finding is that after a financial crisis economic output remains below trend for years:
The blue line shows, for example, that in the average country, output seven years after the crisis was about 10% below what would it would have been if the pre-crisis growth rate had continued.
The dotted red lines, however, highlight the enormous range of outcomes. At least one-quarter of the countries eventually had output that was above the level implied by the earlier trend; while another quarter eventually fell at least 25% below the prior trend.
The study slices and dices this result in numerous ways, trying to identify the factors that lead to better or worse outcomes. Some are bad news for the United States.
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