Public debt 2009, The biggest bill in History. This alarming trend puts policies in an increasingly difficult to constrain. In the short term, government borrowing is an antidote for depression. No bank bail-outs that the financial crisis would have been even more of a disaster. Without the stimulus global recession would be longer and deeper and it is a prolonged recession that makes the most damage to public finances. But in the long term the current fiscal laxity is not sustainable. Governments’ thirsts for funds eventually displace private investment and reduce economic growth. More alarming is that the magnitude of the debt may ultimately come to the government to default or to reduce the real cost of their debt through high inflation.
Investors have been fretting in both cases. Default worries have focused on the weakest countries in the euro area, notably Greece, Ireland, Italy, Portugal and Spain, where the single currency eliminates the unilateral option of inflation (see our special report). Ireland of the debt was lowered for the second time on June 8. Fears of inflation have concentrated on America, where the yields of Treasury ten years reached nearly 4% on June 10, in December the figure was well above 2%. Much of this increase is due to reliance on the economic recovery, rather than fiscal alarm. However, the eyes appear deficits and the unexplored nature of the current monetary policy, the Federal Reserve (like the Bank of England) the printing of money to buy government bonds, are prompting concerns that the debt of America could be inflated away.
Justified or not, this concern is causing damage to themselves. The economic recovery could be killed if interest rates rise too far too fast. And today the policy resources could become increasingly ineffective. Printing more money to buy government debt, for example, could send long-term bond yields higher, rather than less.
What policies should I do? A sudden attack of fiscal restraint would be a mistake. Even when economies fail to decline, this will remain weak. The experience of Japan in 1997 when an increase in consumption taxes pushed the economy into recession is a reminder that a career in the fiscal tightening is counterproductive, especially after a bank failure. Instead of slashing the deficit now, the rich world’s governments must promise credibly do so once their economies are stronger.
But how? Politicians’ promises are not worth much by themselves. Any commitment to prudence should include clear principles of how the deficit was reduced, new rules to tighten the political thorns, and swift action on politically difficult steps that would yield savings in the future without much dent demand today, such as increasing the retirement age.
In general, governments should commit to clean up their public finances by reducing future costs rather than raising taxes. Most European countries have little room to raise taxes. In several, the government hoovers well over 40% of GDP. The tax reform is needed, especially in places like United Kingdom and Ireland, which was based too much on the income of the financial markets and frothy housing bubbles. Even in the United States, where tax revenues are added to less than 30% of GDP, simply raise tax rates is not the best answer. In this case also, the expenditure control should take priority, although there is certainly scope for improving efficiency, fiscal reforms, such as the elimination of preferential tax treatment of housing and the deductibility of employer provided insurance and health.
The next step is to increase the credibility of these principles with the rules and institutions to strengthen the future politicians to solve. United Kingdom Conservative Party wants to create an Intelligent Office of Budget Responsibility “to give an impartial assessment of the government’s plans. Germany is about to approve a constitutional amendment that limits the structural budget deficit to 0.35% of GDP in 2016. Barack Obama’s team wants to resurrect the deficits of control rules. Such bracing must be carefully designed and Germany may be too rigid. But the experience of Chile in Switzerland suggested that the law may limit budgetary belts debauchery.
However, it does not send a stronger signal to take tough decisions today. One priority is to increase the retirement age, which would boost tax revenue (as people work longer) and reduce the cost of future pensions. Many rich countries are already doing, but they have to go farther and faster. Another major objective is health care. America has the most wasteful on the planet. Your future tax would become if Congress approved reforms that emphasized cost control as well as the extension of coverage that Barack Obama wants to right.
All this is a difficult task. Politicians have failed to control the costs of aging for years. Ironically, the bankruptcy, both by the addition of debt, can increase the chances of a breakthrough. If not, another financial disaster looms.