Fiscal Exit Strategies
As the global crisis is winding down and recovery is taking hold in many countries, policy makers are asking themselves what the best exit strategy is from the significant policy interventions that have taken place over the past 18 months. That is not a simple question as there has been an array of fiscal, monetary, and financial crisis interventions. Moreover, the cyclical unwinding of policy measures is intertwined with structural fiscal challenges.
Basic questions for all countries, however, are: when should policymakers unwind crisis-intervention measures, which policies should be unwound first, and when should fiscal retrenchment begin in earnest? Two recently-published IMF Board papers—“Exiting from Crisis Intervention Policies” and “Strategies for Fiscal Consolidation in the Post-Crisis World”—provide a useful framework to address these questions.
The first paper argues that the unwinding of policy responses to the global crisis is state-dependent, i.e., it largely depends on the state of the economy and the health of the financial system. Any premature withdrawal of stimulus might prolong the recession, if the private sector recovery is weak and financial stability is in doubt. However, the paper also argues that exit strategies need to be devised now and clearly communicated to the public as uncertainty may undermine recovery. The design and implementation of these strategies should be performed in the context of achieving sustained and balanced growth.
The second paper focuses on the daunting fiscal challenges ahead, and argues that fiscal deficits and government debt accumulated during the crisis need to be significantly reduced over time. The paper also stresses that dealing with looming pension and health entitlements in many advanced economies will need to be an important part of the solution. The paper’s key findings and recommendations include the following:
· On average, government debt in advanced economies is projected to exceed 100 percent of GDP by 2014 (a level unseen since World War II).
· Stabilizing debt ratios at post-crisis levels will likely lead to higher interest rates, lower medium-term growth, and less flexibility in responding to future crises.
· Reducing government debt to prudent levels will require significant and sustained fiscal adjustment. An illustrative adjustment in the structural primary balance—fiscal balance net of interest and adjusted for economic fluctuations—of 8 percentage points of GDP for advanced economies and phased in over 10 years would be needed to bring debt ratios below 60 percent of GDP by 2030. This adjustment is substantial but not unprecedented.
· Unwinding the fiscal stimulus measures will be a relatively easy first step from a technical standpoint since most of those measures had been temporary in nature. However, this will account for only a small share of the needed effort.
· The bulk of the fiscal adjustment will require more difficult reforms to improve the structural primary balance. Health and pension reforms (including increases in retirement ages and rationalization of benefits) are paramount to stabilizing entitlement spending as a share of GDP (in the absence of corrective measures, health and pension spending will rise by 4-5 percent of GDP over the next two decades in advanced economies). Measures to lower other primary spending and boost revenue in relation to GDP will be needed as well.
· Strengthened institutions should play a crucial role in support of fiscal consolidation. Most countries need to improve fiscal monitoring and reporting, budgeting practices and government assets and liabilities management. Other reforms in the goods, labor, and financial markets to boost potential growth would mitigate the impact of spending cuts and tax increases, making fiscal consolidation easier to implement.
· Some reforms should be initiated now. These include the institutional reforms mentioned above and reforms with long-term effects on spending and revenue that do not place the recovery at risk.