MFSurvey Magazine: What readers say
January 28, 2009
Dear IMF Survey:
At the behest of its Managing Director, the IMF is promoting ("IMF Spells Out Need for Global Fiscal Stimulus" December 29, 2008) a new policy for the institution but a traditional one for the rest of us: Keynesianism.
I am not in favor of a balanced budget at any cost, and I fully recognize the severity of the financial crisis. A fiscal stimulus certainly is needed today. But I do have the following concerns:
• Where today is there room for fiscal expansion?
• Can we afford higher debt? And
• Are fiscal measures really reversible?
Case for fiscal stimulus
Which countries can afford fiscal expansion today? Denmark, China, Chile, oil-producing countries? The authors do not say. For instance, can France, with a tax ratio of 50 percent of GDP, a deficit of 3 percent of GDP, and a public debt burden of 70 percent really afford a strong stimulus? The same question can be asked about most other countries in Europe.
In fact, all countries in Europe have followed a procyclical policy. France had a fiscal deficit close to 3 percent of GDP both during good and bad years: there was no year with a fiscal surplus to reduce the public debt burden. In France, the Maastricht criterion of 3 percent is generally considered as an objective, not a rule.
The same is true of the United States. The U.S. administration should have run a fiscal surplus during the good times, which would have justified a deficit today. But because it didn't, the Congressional Budget Office is now forecasting a fiscal deficit of 8 percent of GDP for FY 2009 (and this is without taking the fiscal stimulus into account). The fiscal deficit may reach 10 percent of GDP in 2009. I ask: which developing countries could afford such a deficit?
Keynes era different
Keynes' name is invoked to justify the need for fiscal stimulus. But when Keynes developed his ideas in 1936, public expenditure to GDP was low (20-25 percent), there were no budget deficits, and central banks were restrictive. We should be careful not to confuse the present situation where public expenditure accounts for more than 40 percent of GDP in advanced economies with the situation in Keynes' days.
But what we need to remember is that because of the scale of social transfers in Europe, automatic stabilizers will do a lot to stimulate the economy even in the absence of discretionary fiscal packages. In addition, the gigantic bailout in the United States will have fiscal repercussions that does not seem to have been accounted for by Blanchard and Cottarelli.
Can we really afford it?
And what about long-term fiscal sustainability? Generally a fiscal deficit is financed by an increase in debt. How will European countries pay back their debt? Will the IMF set up a new initiative for heavily indebted countries?
An increase in public debt is the inescapable consequence of fiscal stimulus, and higher taxes will be needed to pay the money back. But where will economic growth come from in countries that have tax ratios above 50 percent of GDP?
Unwinding will be difficult
Finally, Cottarelli argues that fiscal measures should be reversible, and encourages governments to precommit to unwinding some policies once the economy begins to recover. But, as Milton Friedman famously said, "there is nothing so permanent as a temporary government program." The bulk of public expenditures in Europe are entitlements ("droits acquis" as we call them in France), and for political reasons they are not reversible.
In short, I fear that additional economic growth today will be achieved at the cost of long-term stagnation.