From Here to Eternity: The Outlook for Fiscal Adjustment in Advanced Economies. Carlo Cottarelli Director, Fiscal Affairs Department

Transcription

1 From Here to Eternity: The Outlook for Fiscal Adjustment in Advanced Economies Carlo Cottarelli Director, Fiscal Affairs Department Peterson Institute May 2, 213 1

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3 Main Questions How bad is the fiscal position in advanced economies? What are the risks arising from the poor state of the fiscal accounts? What is the appropriate strategy to address these fiscal challenges? Is the current fiscal adjustment strategy working? 3

4 How Bad is the Fiscal Position in Advanced Economies?

5 General Government Gross Debt 125. Advanced Economies, (Percent of GDP) 213 Level

6 Gross Public Debt to Household Financial Net Worth 14 G-7 Economies, (Percent of GDP) Debt to Household Financial Net Worth (right) Debt to GDP (left)

7 The Outlook is Worse than at the End of WW2 for Four Reasons Most of the fiscal adjustment then consisted of cuts in military spending Spending for pension and health care will be on the rise over the coming decades Growth prospects are not great Financial sector in most advanced economies was repressed Advanced Economies: Population between Ages = =1 1 9 t=1 t=5 t=9 t=13 t=17 t=21 t=25 t=29 7

8 Large Advanced Economies Where Public Debt-to-GDP Ratio Exceeds 9 Percent and Is Still Rising 4 percent of world GDP 8

9 Public Debt and Deficit Since (General Government) AUS KOR Headline deficit, percent of GDP AUT NDL CAN SVK NZL EST DEU CHE FIN SWE CZE DNK Increase in gross debt-to-gdp ratio since 27 9

10 Public Debt and Deficit Since (General Government) Headline deficit, percent of GDP GRC JPN GBR IRL ESP ITA FRA PRT USA BEL Increase in gross debt-to-gdp ratio since 27 1

11 Focus of Long-term FM Scenarios: Degree of Fiscal Tightening Needed to Lower Public Debt to 6-8 percent by Cyclically Adjusted Primary Balance (Percent of GDP) 2.5 Level of the primary balance Size of the adjustment Gross Debt (Percent of GDP) 6 percent

12 Illustrative Long-term Adjustment Scenarios Level of structural primary balance, ITA BEL FRA (Percent of GDP) ESP GBR PRT IRL USA Improvement in structural primary balance, BBR 1/ Legend -1 bp Baseline +1 bp 1/ The BBR (balanced budget rule) scenario targets a debt ratio of 6 percent but caps the balance at.

13 Illustrative Long-term Adjustment Scenarios Level of structural primary balance, (Percent of GDP) JPN Improvement in structural primary balance,

14 What Are the Risks Arising from the Poor State of the Fiscal Accounts?

15 Two Reasons for Concern About High Public Debt Effect of high public debt on long-term economic growth High public debt raises risk of fiscal crises 15

16 Empirical Literature on Debt and Growth Kumar and Woo (21) in 46 AEs and EMEs for Kumar and Woo (213) in 79 AEs, EMEs and LICs for Checherita and Rother (21) in 12 Euro economies for Ceccetti et al. (211) in 18 OECD countries for Balassone et al. (211) for Italy for Ursua and Wilson (212) in AEs and EMEs for Baum et al. (213) in 12 Euro economies for Afonso and Jalles (213) in 155 AEs, EMEs and LICs for Panizza and Presbiterio (212) in 17 countries for

17 Initial Government Debt and Growth of Real GDP Per Capita Over the Following Five-Year Period 15! Real per capita GDP growth (% per annum), average for subsequent 5 years Initial gross government debt (% of GDP) 17

18 Public Debt, Deficits and CDS Spreads Headline deficit Advanced Economies, 212 (Percent of GDP) 1/ ESP JPN 8. GBR USA IRL AUS CZE NZL SVK DNK SVN FIN ISR NLD MLT AUT CAN CYP FRA BEL ISL PRT ITA. EST SWE HKG CHE DEU -2. KOR Gross debt 1/ Balloon size based on 212 average CDS spread. 18

19 Monetization of Public Debt 3. Base Money (Percent of GDP)

20 What is the Appropriate Strategy to Address these Fiscal Challenges?

21 The Austerity Debate Ten Commandments for Fiscal Adjustment in Advanced Economies Olivier Blanchard and Carlo Cottarelli June 24,21 21

22 Recommended Fiscal Adjustment Strategy For countries that are not subject to market pressure, fiscal adjustment should proceed at a moderate pace, within a MT adjustment plan These MT plans should be defined in cyclically adjusted terms so as to allow automatic stabilizers to operate Countries under market pressure should proceed more rapidly, but also for these there is a speed limit This fiscal strategy should be supported by relaxed monetary conditions, and structural reforms to boost trend growth 22

23 Nonlinearities of Fiscal Austerity and Profligacy Cost of policies Cost of profligacy Cost of austerity Degree of fiscal stimulus Cost of policies Total cost Degree of fiscal stimulus 23

24 Costs of Fiscal Tightening are Now High Fiscal multipliers are particularly large now reflecting downward inflexibility of nominal interest rates, the difficulty banks have in extending credit, the large share of households that are credit rationed, and in a recession, cuts in demand will affect output rather than prices. The cost of an output loss is larger when the economy is already growing slowly Higher than usual hysteresis effect 24

25 Fiscal Adjustment and CDS Spreads with Alternative Fiscal Multipliers 25 Change in sovereign five-year CDS spreads (basis points) Higher spending multiplier (1.) Spending multiplier (1.) Spending Lower spending multiplier multiplier (.1) (.1) Reduction in government deficit (percent of GDP) Area where fiscal tightening increases CDS spreads 25

26 Three Issues on the Costs of Fiscal Profligacy A perfect commitment technology does not exist We tend to underestimate the cost of fiscal crises before they occur The risk of turmoil on the government paper market is not the same for all countries but black swan events do occur 26

27 Three Issues on the Costs of Fiscal Profligacy A perfect commitment technology does not exist In the past, advanced economies did not use their good times to lower public debt Fiscal twist already danced in 28-9 Gaining credibility by implementing entitlement reform is not so easy 27

28 General Government Gross Debt 125. Advanced Economies, (Percent of GDP) Level

29 CDS Spreads and Entitlement Spending 4 CDS Spreads, April 213, basis points Increase in Entitlement Spending, 21-3, percentage points 29

30 Japan: General Government Deficit and Debt 11. Headline deficit (Percent of GDP) Gross Debt (Percent of GDP)

31 Advanced Economies 213 Net Public Debt, Headline Deficit and Primary Deficit, percent of GDP Net Public Debt Primary deficit Deficit 31

32 Advanced Economies 21 Net Public Debt, Headline Deficit and Primary Deficit, percent of GDP Net Public Debt Primary deficit Deficit 32

33 United States: Largest Fiscal Tightening in the Last 3 Years 2. General Government, Improvement in Cyclically Adjusted Primary Balance (Percent of GDP)

34 United States: General Government Deficit Headline deficit (Percent of GDP) percent percent

35 Stability Programs: 211 and 213 General Government Headline Balance Targets (Percent of GDP) Netherlands Portugal Old targets Old targets New targets -4. New targets Spain Ireland Belgium Old targets New targets France Old targets New targets Old targets Italy Old targets Old targets New targets New targets -3.3 New targets

36 Is This Strategy of Steady Fiscal Adjustment Working and is it Realistic to Continue it in the Future?

37 Advanced Economies: Average Deficit Will Be Half of What It Was in and 213, General Government Deficit (Percent of GDP) GDP weighted average 29 6 GDP weighted average JPN IRL GBR SVN ESP USA PRT GRC FRA ISR NDL SVK CZE CAN DNK BEL ITA AUT FIN NZL ISL AUS SWE DEU CHE EST HKG KOR SNG NOR 37

38 Advanced Economies: In 213, Average Public Debt Will Stop Rising 12. General Government Debt (Percent of GDP)

39 23 Advanced Economies: Historical Evidence on Primary Balances, (New FAD Database) Maximum Primary Surplus Maximum Improvement in Primary Surplus Number of Countries Maximum 1-year Average Primary Surplus (Percent of GDP) Maximum 7-Year Adjustment (Percent of GDP) 39

40 Illustrative Long-term Adjustment Scenarios (Percent of GDP) Level of structural primary balance, IRL ITA PRT BEL USA ESP GBR FRA Improvement in structural primary balance,

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