The False Fiscal Choice

I admire this level-headed piece by the IMF's Olivier Blanchard and Carlo Cottarelli. The debate on the need for further fiscal stimulus in the US and elsewhere has indeed, as they argue, become needlessly ideological and extreme. The choice is not about stimulus or austerity. It is about how far to front-load the fiscal adjustment, and how far to persist with it when circumstances permit.

[S]ome clearly prefer more front-loaded consolidation, others less. Front-loaders point to the need to maintain credible fiscal policy, which is hard to gain and easy to lose. They note that market perceptions of fiscal health can shift in a heartbeat, so countries must move pre-emptively.

Back-loaders respond that, if hasty adjustment derails growth, credibility will also be a casualty. To use Larry Summers' apt expression, recent growth numbers show that advanced economies have not yet achieved escape velocity. Withdrawing fiscal accommodation too early could therefore jeopardise the recovery, especially when - measures announced this week by the Fed notwithstanding - the monetary policy arsenal has been effectively drained. When private demand picks up, they argue, consolidation will be easier and safer.

Fortunately, there is a path through these thorns. Front-loading can be avoided if moderate adjustment today comes with further savings in the future. And such options are available, desirable and, in many cases, more politically feasible than front-loaded spending cuts.

Yes. Blanchard and Cottarelli also underline another important point.

Today's debt problems, therefore, result not from how fiscal policy was managed during the crisis, but rather from how it was mismanaged before the crisis. Advanced countries entered the crisis with some of the highest public debt ratios ever reached in the absence of a major war. A basic fiscal policy lesson of sowing in good times and reaping in bad times was ignored.

This matters not because one wants to know who to blame for what has happened--although it is as well to keep that in mind. It matters because, once this crisis is behind us, it will be essential to prepare for the next. Imagine going into the next Great Recession with levels of public debt at anything like currently projected long-term levels.

It will be a mistake to move too soon. And I don't know if I agree with the article when it calls for "an initial downpayment", at least so far as the US is concerned: the US has room for additional short-term stimulus. But refusing even to discuss longer-term consolidation until the economy is back on its feet is an even bigger mistake.