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In a recent interview Carlo Cottarelli, head of the IMF’s Fiscal Affairs Department, and José Viňals, head of the Monetary and Capital Markets Department, discussed what might happen if fiscal policies are left unaddressed.
Both agreed that it is still too soon to unwind the policies put in place to fight the crisis. But, now that recovery has taken hold, they urged policymakers to start thinking about how to return their fiscal and monetary positions to a more normal state of affairs.
To the question of what should countries do with the current fiscal situation, Cottarelli said that countries should work to get their public debt down to significantly lower levels. The IMF has computed that in order to bring down public debt to about 60 per cent of GDP over the next 20 years, advanced countries will need to improve their cyclically adjusted primary fiscal balance by at least 8 percentage points within the next 10 years, moving from a deficit of 3.5 per cent of GDP to a surplus of 4.5 per cent. Governments should start with the obvious: allowing the current fiscal stimulus to expire once recovery is well established. This will improve the average fiscal position by 1½ percentage points.
Cottarelli remarked that that public debt is increasing rapidly and will continue to do so in the near future. This is a result of revenue losses from the recession, as well as fiscal stimulus packages and interventions to stabilize the financial sector—actions that were necessary to support the economy during the global economic crisis. But it has meant an increase in the public debt of advanced countries that is unprecedented in peace time. And, to make matters worse, it comes on top of the medium-term pressure from demographics.
Viňals added that things are more manageable on the monetary than on the fiscal side, even though we shouldn’t underestimate the risks. He estimated that 80 per cent of the effort to ensure long-term sustainability needs to come from fiscal policy, with the remaining 20 per cent left for monetary policy to deal with.
During the crisis, central banks basically did two things. They reduced interest rates to very low levels to support economic activity and they used unconventional monetary policy tools to support the financial sector. As a result, they now face two related challenges. They need to figure out when, and at what pace, to begin raising interest rates. Getting this timing right will be essential.