Academic journal article The Economic and Labour Relations Review : ELRR

The Debate on Expansionary Fiscal Consolidation: How Robust Is the Evidence?

Academic journal article The Economic and Labour Relations Review : ELRR

The Debate on Expansionary Fiscal Consolidation: How Robust Is the Evidence?

Article excerpt

Introduction

The 2007-2009 global economic and financial crisis led to a sharp increase in public debt across various parts of the world, especially in advanced countries. This has heightened concerns about fiscal sustainability and its broader economic and financial market consequences. In particular, many believe that public debt is starting to hit levels at which it might slow down economic growth. These concerns have already triggered further downgrading of the sovereign debt ratings of several developed economies, including Greece, Ireland, Japan, Portugal and Spain. One rating agency, Standard & Poor's, has recently presented a negative outlook for the debt burden of France, and downgraded its triple A credit rating, following its downgrading of the United States in 2011. On 13 February, 2012, Moody's Investor Service downgraded its credit ratings for Italy, Portugal and Spain, while France, Britain and Austria kept their top ratings but had their outlooks dropped to 'negative' from 'stable'.

The consensus among the major countries represented in the Group of 20 (G20) in the wake of the current global economic and financial crisis that propelled them to announce coordinated stimulus packages quickly disappeared with the first signs of a tepid recovery. Following the 2010 Toronto Summit of the G20 leaders, many countries, especially in Europe, have committed to fiscal consolidation in response to these concerns in the form of time-bound and targeted reductions in the structural budget deficit. For example, fiscal austerity measures in the United Kingdom aim to cut the deficit by an estimated 8 percentage points of GDP by 2015. (1) In France, the medium-term fiscal plan is to reduce the deficit to 3 per cent of GDP by 2013 through a mix of revenue and expenditure measures as well as structural reforms. Fiscal consolidation in Germany started in 2011. The Stability and Growth Pact (SGP) of Germany requires lowering the general government deficit to 3 per cent of GDP by 2013; and the constitutional rule mandates a 0.35 structural deficit at the federal level by 2016 (to be achieved in roughly equal annual steps) and balanced structural budgets at the state level by 2020. (2) Canada's fiscal consolidation plan projects a return to a small deficit of -0.1 per cent of GDP by 2014-15. The winding-down of the Action Plan would cut the federal budget deficit in half by 2011-12.

The policy discourse, most notably in the rich nations, is that governments must now engage in fiscal consolidation and bring back public finances to sustainable levels. As the Economist (2010a) observes: Across much of the rich world an era of budgetary austerity beckons'. But signs of budgetary austerity also seem to be emerging in a sizeable number of low and middle-income countries. One study by UNICEF (2010) finds that, in a sample of 86 low and middle income countries, about 40 per cent are engaging in reductions in public expenditure in 2010-2011 relative to 2008-2009.The average projected spending cuts are around 2.6 per cent of GDP. An OXFAM study (Kyrili and Matthew 2010) shows that the global economic and financial crisis of 2007-2009 has created a huge 'fiscal hole' in the 56 low-income countries (LICs) by reducing their budget revenues by $65bn over the 2009-2010 period. As a result of the fiscal hole, most LICs are cutting or at least restraining public expenditure, especially on education and social protection.

The International Monetary Fund's Fiscal Monitor (IMF 2010c) highlighted the need for major fiscal consolidation over the years ahead. The monitor stated that though the increase in budget deficits played a key role in staving off an economic catastrophe, as economic conditions improve, the attention of policymakers should now turn to ensuring that doubts about fiscal solvency do not become the cause of a new loss of confidence. Moreover, an equally important risk to be averted is that the accumulated public debt, even if does not result in overt debt crises, becomes a burden that slows down long-term potential growth. …

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