When we get enough perspective to write a balanced history of the 2008 global financial crisis and the subsequent feeble recovery, fiscal policy mistakes will surely feature largely in the narrative. In the form of a new IMF paper, we are beginning to see that history taking shape, and with it a clearer idea of what fiscal policy should have done.
After a bold start with the G20-coordinated fiscal stimulus of 2009, the Greek crisis at the end of that year (and the knock-on crises in Ireland, Spain, Italy and Portugal) shifted the focus onto excessive public debt. Instead of making a distinction between these grossly over-indebted countries and others in which the debt was easily sustainable, there was a universal shift to budget tightening in the advanced economies, urged on by all the international economic agencies – the IMF, the OECD and the Bank of International Settlements. The result of this fiscal austerity has been a pathetically weak recovery which has left per capita GDP in quite a few advanced countries not much higher than it was before the crisis, seven years ago.
Some of the IMF's most heterodox thinkers have now begun to make this distinction, which was missing in the rush to austerity in 2010. The full paper is here, but a more accessible version is here.
To make sense of the complexity involved in fiscal policy, the authors separate the debt analysis from the heated debate about Keynesian stimulus versus fiscal austerity (whether budget deficits boost the economy through the usual Keynesian stimulatory effects, or alternatively whether a round of fiscal austerity would work better by boosting private sector confidence). Instead, they focus just on the debt.
Should countries that find themselves, post-crisis, with a substantial increase in debt make it a matter of priority to get this debt down? [fold]
If a country pays down its debt, it has to do so by raising revenue or lowering spending, which will slow growth. On the other hand, once the debt is down, underlying growth will be faster because the cost of servicing debt will be a smaller burden on the economy. What's the trade-off here? The IMF authors argue that these two effects are equal, so there is no compelling reason to think that getting the debt down is a policy priority. As they say, 'When and only if countries have ample fiscal space, there is no need to obsess about paying down the debt. Living with the debt is likely to be the better policy.'
They offer the graph below, which identifies the countries with 'fiscal space'. It's worth noting that in an international comparison, Australia's public debt level is modest and its fiscal space large. You might wonder why the political-economy narrative here is centred on getting the budget into surplus.
Not that this Fund paper is in itself a sufficient basis for policy. To start with, its analytical simplifications need to be taken into account. And there are many other aspects of fiscal policy that need to be considered.
Why not, for example, use the opportunity of low interest rates and spare productive capacity to issue more debt to fund socially profitable infrastructure? Such debt liabilities would then be balanced by the infrastructure assets. If the latter are well chosen, the government's net debt position is stronger, not weaker.
The fiscal rethink at the Fund is also exploring how to make automatic fiscal stabilisers work better so that governments don't simply spend the extra revenue that accrues to them in the cyclical upswing (or, more typically, offer vote-winning tax cuts), but instead put it aside to cover the fall in revenue and extra social expenditure that accompany the downturn of the cycle. The ABC's just-screened The Killing Season touched on the lamentable story of how we fumbled the opportunity to put in place the key element of strong automatic stabilisation in the form of a counter-cyclical super-tax on our minerals industry.
The influence of the Fund's analysis is strengthened because this rethink comes from such a fiscally conservative institution (it's often said that IMF really stands for 'it's mainly fiscal'). Better late than never.
Photo courtesy of Flickr user International Monetary Fund.