By Jean-Claude Trichet
Published: July 22 2010 20:47
The acute fiscal challenges across all industrial economies are no surprise. Our economies are emerging from the worst economic crisis since the second world war, and without the swift and appropriate action of central banks and a very significant contribution from fiscal policies, we would have experienced a major depression. But now is the time to restore fiscal sustainability. The fiscal deterioration we are experiencing is unprecedented in magnitude and geographical scope. By the end of this year, government debt in the euro area will have grown by more than 20 percentage points over a period of only four years, from 2007-2011. The equivalent figures for the US and Japan are between 35 and 45 percentage points.
The growth of public debt has been driven by three phenomena: a dramatic diminishing of tax receipts due to the recession; an increase in spending, including a pro-active stimulus to combat the recession; and additional measures to prevent the collapse of the financial sector. Because we avoided the catastrophic scenario of a financial meltdown, the third element does not represent a very significant volume of spending for most countries. But calculations by the European Central Bank show the volume of taxpayer risks earmarked to support the financial sphere, including all options – recapitalisation, guarantees, toxic assets etc – was as high as 27 per cent of gross domestic product. It is, remarkably, the same gigantic proportion on both sides of the Atlantic.
Taking account of these facts, there is a strong unity of purpose among the world’s policymakers to address our fiscal fragilities. It is reassuring that the consensus on the need for credible fiscal exit strategies, along with profound financial sector reform, is very broad. But the timing remains disputed. In the waiting camp, some argue that it would be desirable to maintain or even increase the fiscal stimulus to avoid jeopardising the economic recovery. Others claim that fiscal consolidation will have a negative systemic impact on the global economy by damping the growth environment. I disagree with both these views. We have to avoid an asymmetry between bold, if justified, loosening and unduly hesitant retrenchment. There are three main reasons for starting well-designed fiscal consolidation strategies in the industrial countries now, precisely to consolidate the present recovery.
First, we have the experiences of fiscal consolidation episodes in less exceptional times, which make clear the long-term benefits of reducing sizeable fiscal imbalances. These experiences also suggest that, provided consolidation is pursued as part of a comprehensive reform strategy, the short-term costs for economic growth tend to be contained or very limited. The success of a fiscal consolidation strategy strongly depends on its design. Adjustment on the spending side, accompanied by structural reforms to promote long-term growth, has typically been the best strategy, especially when combined with a credible long-term commitment to fiscal consolidation.
Second, given the magnitude of annual budget deficits and the ballooning of outstanding public debt, the standard linear economic models used to project the impact of fiscal restraint or fiscal stimuli may no longer be reliable. In extraordinary times, the economy may be close to non-linear phenomena such as a rapid deterioration of confidence among broad constituencies of households, enterprises, savers and investors. My understanding is that an overwhelming majority of industrial countries are now in those uncharted waters, where confidence is potentially at stake. Consolidation is a must in such circumstances.
Third, systemic economic stability – and therefore sustainable growth – relies on the ultimate capacity of public finances to intervene in difficult circumstances. Fiscal buffers are essential when our economies are in a typical business cycle. They are even more necessary when our economies are coping with exceptional circumstances. Had our public finances not been credible when that 27 per cent of GDP of taxpayer risk was mobilised, we would not have avoided a financial meltdown and a second Great Depression. We are doing all that is possible to avoid a future economic catastrophe resulting from the extreme malfunctioning of the financial sector. And I am convinced that we will succeed. But even with the best G20 financial reform there may be many different triggers for economic and financial dislocation. Other unexpected events, including natural catastrophes, may need emergency fiscal support. Sound public finances are a decisive component of economic stability and sustainable global growth.
With hindsight, we see how unfortunate was the oversimplified message of fiscal stimulus given to all industrial economies under the motto: “stimulate”, “activate”, “spend”! A large number fortunately had room for manoeuvre; others had little room; and some had no room at all and should have already started to consolidate. Specific strategies should always be tailored to individual economies. But there is little doubt that the need to implement a credible medium-term fiscal consolidation strategy is valid for all countries now.
In the extraordinary circumstances we have experienced since 2007, central banks across the Atlantic, the Channel, the Pacific and all over the world have demonstrated a remarkable capacity to analyse unprecedented situations and take appropriate decisions. They have designed their monetary policy stance to preserve the credibility of price stability in the face of both inflationary and deflationary risks. They have implemented transitional non-standard measures aimed at improving the functioning of certain segments of financial markets that are essential for the transmission of monetary policy. And they have engaged in unprecedented international co-operation. The ECB, which acted at the very start of the financial turmoil on August 9 2007, will contribute to consolidate a confident economic environment by ensuring price stability in the euro area as we have done for more than a decade. We expect governments to confirm their determination to consolidate their public finances. That commitment is as important today for the G20 paradigm of “strong, sustainable and balanced” growth as yesterday were their exceptionally bold decisions to avoid a depression.
The writer is president of the European Central Bank
Copyright The Financial Times Limited 2010.
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