Wednesday, August 3, 2011

Credible long-tem fiscal plans still elusive, still needed, but unlikely

While there is considerable relief the US has narrowly avoided a (technical) default, the just-concluded debt ceiling debacle is a sign of things to come. But it didn’t have to be this way.

Let’s remember what the GFC was all about: for many developed economies it was (and still is) a correction following many years of spending and living beyond our means. Over that period unsustainable fiscal, particularly entitlement, polices were introduced. Pre GFC, there were a number of years before these issues needed to be confronted. The GFC and its aftermath which included, in many countries, lower potential growth, higher debt levels and large structural budget deficits, has closed up the timeframe for dealing with those issues to NOW.

I know it’s a long-time ago, but those of you with good memories will recall that when we first started thinking about stimulus “exit strategies” a couple of years ago, we made the point that Governments needed to articulate credible medium-term plans to achieve fiscal sustainability. Failure to do so would result in markets dictating the course of events.

That would result in ad-hoc short-term piece-meal solutions to what are essentially big long-term problems. That’s just what we have been witnessing in Europe and now America: the failure of politicians to develop and then articulate credible medium term plans for fiscal consolidation.

That approach looses an important element of balance. If politicians developed long-term plans, it would be easier to strike the appropriate balance between supporting economic growth and getting ones fiscal house in order. Fiscal consolidation doesn’t need to happen today. Markets just need to know today how it’s going to happen in the future. That could be a (credible) 10-year plan.

That would require politicians to openly acknowledge that spending cuts need to be made and/or taxes need to be raised. But politicians don’t like taking things off people. Developed world debt issues aren’t going away any time soon.