To live up to its growth potential and secure its inclusive social model, the euro area must make better use of its available labor. In the aftermath of the crisis, boosting growth is essential to prevent unemployment from becoming a long-term problem and to facilitate the return to fiscal sustainability. Labor utilization in the euro area has been lagging considerably behind its best performing peers. While fewer hours worked may, to some extent, reflect a social choice, higher unemployment rates and lower participation rates, on the other hand, cannot easily be attributed to individual preferences. Here, policies and institutions matter more. And there is little excuse for relatively low labor productivity, a particular bane in southern Europe and an increasing challenge everywhere. Kick-starting growth requires a comprehensive approach to labor and service market reforms. Different circumstances call for different approaches across countries. Countries in southern Europe need to focus on regaining competitiveness, while some in the core should promote higher labor force participation or more open service sector markets. Improving access to the labor market should be high on the priority list everywhere—including through some harmonization of key features of the labor market, which will help deal with intra-euro area imbalances. Differences in labor taxation, unemployment benefit systems, and employment protection will need to be reduced. Improving regulation and reforming taxes and social benefits will be essential to make inroads. For the longer term, focus should be on innovation, education, and on continuing financial sector reforms.
Mr. Jonathan David Ostry, Mr. Atish R. Ghosh, Mr. Jun I Kim, and Miss Mahvash S Qureshi
In this note, the authors reexamine the issue of debt sustainability in a large group of advanced economies. Their hypothesis is that, when debt is in a moderate range, its dynamics are sustainable in the sense that increases in debt elicit sufficient increases in primary fiscal balances to stabilize the debt-to-GDP ratio. At high debt levels, however, the dynamics may turn unstable, and the debt ratio may not converge to a finite level. Such a framework allows the authors to define a “debt limit” that is consistent with a country’s historical track record of adjustment in the sense that, without an extraordinary fiscal effort, any debt increment beyond this limit would cause debt to increase without bound. This debt limit is not an absolute and immutable barrier, however, but rather defines a critical point above which a country’s normal fiscal response to rising debt becomes insufficient to maintain debt sustainability. Nor should this debt limit be interpreted as being in any sense the optimal level of public debt. Indeed, since this limit delineates the point at which fiscal solvency is called into question—and the analysis abstracts entirely from liquidity/rollover risk—prudence dictates that countries will typically want to be well below their debt limit. Given a country’s normal pattern of adjustment, “fiscal space” is then simply the difference between its debt limit and its current level of debt.
Mr. Carlo Cottarelli, Mr. Paolo Mauro, Lorenzo Forni, and Jan Gottschalk
This note summarizes the main arguments put forward by some market commentators who argue that default is inevitable, and presents a rebuttal for each argument in turn. Their main arguments focus on the size of the adjustment and continued market concerns reflected in government bond spreads. The essence of our reasoning is that the challenge stems mainly from the advanced economies’ large primary deficits. Thus, by lowering the interest bill while triggering the need to move to primary balance or a small primary surplus, default would not significantly reduce the need for major fiscal adjustment. In contrast, the emerging economies that defaulted in recent decades did so primarily as a result of high debt servicing costs, often in the context of major external shocks. We conclude that default would be ineffective and undesirable in today’s advanced economies.
Today’s record public debt levels in most advanced economies are not only a direct fall-out from the global crisis. Public debt had ratcheted up over many decades before, when it had been used, in most of the G-7 countries, as the ultimate shock absorber—rising in bad times but not declining much in good times. Alongside, primary spending increased, particularly during 1965–85, reflecting predominantly a surge in health care and pension spending. Looking ahead, advanced economies will face the formidable challenge of reducing debt ratios at a time when ageing-related spending, in particular often underestimated pressures from health care systems, will put additional pressure on public finances. Addressing these fiscal challenges will require growth-friendly structural reforms, a fiscal strategy involving gradual but steady fiscal adjustment, stronger fiscal institutions, expenditure and revenue reforms, and an appropriate degree of burden sharing across all stakeholders.
Mr. Olivier J Blanchard, Mr. Giovanni Dell'Ariccia, and Mr. Paolo Mauro
The great moderation lulled macroeconomists and policymakers alike in the belief that we knew how to conduct macroeconomic policy. The crisis clearly forces us to question that assessment. In this paper, we review the main elements of the pre-crisis consensus, we identify where we were wrong and what tenets of the pre-crisis framework still hold, and take a tentative first pass at the contours of a new macroeconomic policy framework.
Mr. Gian M Milesi-Ferretti and Mr. Olivier J Blanchard
This chapter analyses various reasons for global imbalances and ways to tackle these issues. Current account balances reflect a plethora of macroeconomic and financial mechanisms. The overall assessment is that the pre-crisis policy advice and the conclusions from the Multilateral Consultations still largely hold. Namely, it is important to address domestic and systemic distortions. It is recommended to increase private and public US saving. The private part has largely taken place. The public part will have to take place over time. This will be good for the United States and help global rebalancing. In the fallout from the financial crisis, the adjustment process of global imbalances has started. However, stopping in midstream is dangerous—while imbalances are smaller than they used to be, the world economy is fragile. Failure to act on the remaining domestic and systemic distortions that caused imbalances would threaten the nascent recovery.
Mr. Vladimir Klyuev, Phil De Imus, and Mr. Krishna Srinivasan
This paper examines the unconventional monetary policy actions undertaken by G-7 central banks and assesses their effectiveness in alleviating financial market pressures and facilitating credit flows to the real economy. Central banks acted nimbly, decisively, and creatively in their response to the deepening of the crisis. They embarked on a number of unconventional policies, some of which had been tried before, while others were new. The scale and scope of unconventional measures have differed substantially across major central banks. Massive asset purchases have boosted the size of the central bank balance sheets the most in the United States and the United Kingdom. However, the Bank of England has relied primarily on the purchases of government bonds, while the Fed has acquired a variety of assets, including commercial paper and mortgage-backed securities and providing financing for acquisition of other asset-backed securities. Central bank interventions, along with government actions, have been broadly successful in stabilizing financial conditions over time.
This paper highlights the state of Public Finances Cross-Country Fiscal Monitor. This edition of the Cross-Country Fiscal Monitor provides an update of global fiscal developments and policy strategies, based on projections from the November 2009 WEO. These projections reflect the assessment of IMF staff of current country policies and initiatives expected during 2009–2014 Underlying fiscal trends in advanced economies are weaker than previously projected, however, lower expected costs of financial sector support in the United States mean that 2009 headline numbers are better. New estimates of needed medium-term fiscal adjustment in advanced economies. Fiscal policy will continue to provide substantial support to aggregate demand in most countries this year, but a tightening is projected to commence next year in G-20 emerging markets. Fiscal policy is projected to begin tightening in emerging G-20 economies next year, reflecting a combination of reduced anti-crisis spending and expected consolidation beyond the withdrawal of crisis-related stimulus in Brazil, Mexico, and Turkey, supported by a pick-up of growth. Higher commodity prices are also expected to contribute to lower overall deficit.
In response to the worst economic crisis since the 1930s, government budgets and central banks have provided substantial support for aggregate demand and for the financial sector. In the process, fiscal balances have deteriorated, government liabilities and central bank balance sheets have been expanded, and risks of future losses for the public sector have increased.
Mr. Paolo Mauro, Mr. Mark A Horton, and Mr. Manmohan S. Kumar
This paper presents sharp increase in government debt has complicated the management of preexisting challenges from population aging, especially in advanced economies. The increase in debt ratios projected for these economies is the largest since World War II. The increase in deficits and debt raises complicated tradeoffs. Policymakers will need to balance two competing risks: on the one hand, a too hasty withdrawal of fiscal stimulus would risk nipping a recovery in the bud; on the other hand, with a delayed withdrawal investor concerns about sustainability may increase, leading to higher interest rates on government paper, undermining the recovery and increasing risks of a snowballing of debt. Regardless of the timing of adjustment, its necessary scale will be quite large, particularly for high-debt advanced economies. Preserving investor confidence in government solvency is key to avoiding an increase in interest rates, thereby not only preventing snowballing debt dynamics, but also ensuring that the fiscal stimulus is effective.