♠ Posted by Emmanuel in IMF at 1/01/2012 08:05:00 AMIMF Chief Economist Olivier Blanchard writes about the "four hard truths" from 2011 that should interest most readers. Alike other economists, Blanchard is ambiguous on fiscal consolidation--its magnitude and the timing of when it's implemented. I have previously commented on the unreality of the widely-held idea that the US for instance should splurge now and retrench later based on the observation that America's national government has not managed to decrease its expenditures since 1965. Expanding government generates its own momentum into the future. There's also more than a smidgen of hypocrisy involved now that industrialized countries (from which many of these economist types comes from, you will observe) instead of developing ones are enduring hard times. Go easy on the richer ones, yeah?
That said, here is another Blanchard-ism for you concerning how markets seem to welcome announcements of fiscal consolidation but do not welcome the resulting slowdown in growth...
Financial investors are schizophrenic about fiscal consolidation and growth.Is it a "deficits don't matter since the markets will punish slower resulting economic growth from austerity" argument? I submit that Dick Cheney's durable and adaptable economic belief system remains worthy of a Nobel Prize given its modern ubiquity.
They react positively to news of fiscal consolidation, but then react negatively later, when consolidation leads to lower growth—which it often does. Some preliminary estimates that the IMF is working on suggest that it does not take large multipliers for the joint effects of fiscal consolidation and the implied lower growth to lead in the end to an increase, not a decrease, in risk spreads on government bonds. To the extent that governments feel they have to respond to markets, they may be induced to consolidate too fast, even from the narrow point of view of debt sustainability.
I should be clear here. Substantial fiscal consolidation is needed, and debt levels must decrease. But it should be, in the words of Angela Merkel, a marathon rather than a sprint. It will take more than two decades to return to prudent levels of debt. There is a proverb that actually applies here too: “slow and steady wins the race.”