This article is a guest contribution by Olivier Blanchard, Chief Economist, IMF (on leave from MIT) and Carlo Cottarelli, IMF, via VoxEU.org.
Advanced economies are facing the difficult challenge of implementing fiscal adjustment strategies without undermining a still-fragile economic recovery. Fiscal adjustment is key to high private investment and long-term growth. It may also be key, at least in some countries, to avoiding disorderly financial market conditions, which would have a more immediate impact on growth through effects on confidence and lending. But too much adjustment could also hamper growth, and this is not a trivial risk. How should fiscal strategies be designed to make them consistent with both short-term and long-term growth requirements?
We offer ten commandments to make this possible. Put simply, what advanced countries need is clarity of intent, an appropriate calibration of fiscal targets, and adequate structural reforms – with a little help from monetary policy and their (emerging market) friends.
- Commandment I: You shall have a credible medium-term fiscal plan with a visible anchor (in terms of either an average pace of adjustment, or of a fiscal target to be achieved within 4–5 years).
There is no simple one-size-fits-all rule. Our current macroeconomic projections imply that an average improvement in the cyclically-adjusted primary balance of some 1 percentage point per year during the next four to five years would be consistent with gradually closing the output gap, given current expectations on private sector demand, and would stabilise the average debt ratio by the middle of this decade. Countries with higher deficits/debt should do more; others should do less. Such a pace of adjustment must be backed up by fairly specific spending and revenue projections and supported by structural reforms (see below).
- Commandment II: You shall not front-load your fiscal adjustment, unless financing needs require it.
For a few countries, frontloading may be needed to maintain access to markets and finance the deficit at reasonable rates – but, in general, a steady pace of adjustment is more important than front-loading, which could undermine the recovery and be reversed. Nonetheless, a non-trivial first installment is needed; promises of future action will not be enough.
