17 September 2013

IMF: Reassessing the role and modalities of fiscal policy in advanced economies

The IMF deems that austerity plans in developed economies had to be restricted. Indeed the report shows how austerity can be counterproductive if it is implemented to the extreme and also that it "impedes growth".

This paper investigates how developments during and after the 2008–09 crisis have changed economists’ and policymakers’ views on:

1. fiscal risks and fiscal sustainability;
2. the effectiveness of fiscal policy as a countercyclical tool;
3. the appropriate design of fiscal adjustment programmes;
4. the role of fiscal institutions.

Advanced economies have experienced much larger shocks than was previously thought possible and sovereign-bank feedback loops have amplified sovereign debt crises. This has led to reassessing what constitutes "safe" sovereign debt levels for advanced economies and has prompted a more risk-based approach to analysing debt sustainability. Precrisis views about the interaction between monetary and fiscal policy have also been challenged by the surge in central bank purchases of government debt. This has helped restore financial market functioning, but, to minimise the risk of fiscal dominance, it is critical that central bank support is a complement to, not a substitute for, fiscal adjustment. 

The design of fiscal adjustment programmes, and particularly the merit of frontloading, has returned to the forefront of the policy debate. Given the non-linear costs of excessive frontloading or delay, countries that are not under market pressure can proceed with fiscal adjustment at a moderate pace and within a medium-term adjustment plan to enhance credibility. Frontloading is more justifiable in countries under market pressure, though even these countries face "speed limits" that govern the desirable pace of adjustment. The proper mix of expenditure and revenue measures is likely to vary, depending on the initial ratio of government spending to GDP, and must take into account equity considerations. 

Full report

© International Monetary Fund