Fiscal consolidation: At what speed?

Olivier Blanchard, Daniel Leigh, IMF, 3 May 2013. voxeu

The debate about fiscal consolidation reduces too often to shouting matches about the value of fiscal multipliers, or about the existence of a critical debt-to-GDP ratio. This does not do justice to what is a complex choice, depending on many factors. Our purpose in this article is to review the relevant factors at play and allow for a richer discussion.

In many advanced economies, public debt is very high, and fiscal consolidation must take place. Some factors point to doing more now, others to doing more later. Our purpose in this article is to identify these factors. The right decision, for each country, must depend on a careful weighting of the factors at play.

Less now, more later. Multipliers.

When fiscal multipliers are large, government spending cuts and tax hikes have a large adverse effect on output in the short run, and a small initial effect on the ratio of debt to GDP (Eyraud and Weber, 2013). Indeed, as GDP may initially decline by more than debt, it may lead to an initial increase in the debt-to-GDP ratio, something we have seen in a number of countries in this crisis. (All that is needed, for example, is a multiplier above 1 and the sum of the ratio of revenue-to-GDP and the debt-to-GDP ratio above 100 per cent).

Large multipliers do not necessarily affect the optimal timing of fiscal consolidation, however. If they remain just as large in the future, the adjustment will be as painful later. But, if they are larger now than later, this tilts the adjustment toward doing more later: Less pain now, less pain later. And there are at least three reasons to believe that multipliers are larger now.

We May Have Avoided the Cliffs, But We Still Face High Mountains

Posted on January 23, 2013 by iMFdirect

by Olivier Blanchard. He is currently on leave from MIT, as Economic Counsellor and Director of the Research Department of the International Monetary Fund

Optimism is in the air, particularly in financial markets. And some cautious optimism may indeed be justified.

Compared to where we were at the same time last year, acute risks have decreased. The United States has avoided the fiscal cliff, and the euro explosion in Europe did not occur. And uncertainty is lower.

But we should be under no illusion. There remain considerable challenges ahead. And the recovery continues to be slow, indeed much too slow. 

Put poetically: We may have avoided the cliffs. But we still face high mountains.

A year ago, we were worried about two short term risks:

We were worried that gridlock might lead to excess fiscal consolidation in the United States. And that firewalls in Europe may not be strong enough to prevent a crisis in Spain or Italy.

Driving the Global Economy with the Brakes On

Author: Olivier Blanchard, IMF · January 24th, 2012 ·

After the speech by the IMF’s Managing Director in Berlin yesterday, my main messages on the global outlook will not surprise you.

Starting with the bad news–the world recovery, which was weak in the first place, is in danger of stalling. The epicenter of the danger is Europe, but the rest of the world is increasingly affected.

There is an even greater danger, namely that the European crisis intensifies. In this case, the world could be plunged into another recession.

Turning to the good news–with the right set of measures, the worst can definitely be avoided, and the recovery can be put back on track. These measures can be taken, need to be taken, and need to be taken urgently.