Home » Opinion » Foreign Views
Monetized long-term deficits will put choke-hold on growth
By Nouriel Roubini |
January 20, 2010, Wednesday
|
Print Edition
Print Edition
TODAY'S swollen fiscal deficits and public debt are fueling concerns about sovereign risk in many advanced economies. Traditionally, sovereign risk has been concentrated in emerging-market economies.
But, in large part - and with a few exceptions in Central and Eastern Europe - emerging-market economies improved their fiscal performance by reducing overall deficits, running large primary surpluses, lowering their stock of public debt-to-GDP ratios, and reducing the currency and maturity mismatches in their public debt.
As a result, sovereign risk today is a greater problem in advanced economies than in most emerging-market economies. Indeed, rating-agency downgrades, a widening of sovereign spreads, and failed public-debt auctions in countries like the United Kingdom, Greece, Ireland, and Spain provided a stark reminder last year that unless advanced economies begin to put their fiscal houses in order, investors, bond-market vigilantes, and rating agencies may turn from friend to foe.
In the future, a weak economic recovery and an aging population are likely to increase the debt burden of many advanced economies, including the United States, the UK, Japan, and several euro-zone countries.
More ominously, monetization of these fiscal deficits is becoming a pattern in many advanced economies, as central banks have started to swell the monetary base via massive purchases of short- and long-term government paper.
Tricky business
Eventually, large monetized fiscal deficits will lead to a fiscal train wreck and/or a rise in inflation expectations that could sharply increase long-term government bond yields and crowd out a tentative and so far fragile economic recovery.
Fiscal stimulus is a tricky business. Policy makers are damned if they do and damned if they don't.
If they remove the stimulus too soon by raising taxes, cutting spending, and mopping up the excess liquidity, the economy may fall back into recession and deflation. But if monetized fiscal deficits are allowed to run, the increase in long-term yields will put a choke-hold on growth.
Countries with weaker initial fiscal positions - such as Greece, the UK, Ireland, Spain, and Iceland - have been forced by the market to implement early fiscal consolidation.
While that could be contractionary, the gain in fiscal-policy credibility might prevent a damaging spike in long-term government-bond yields. So early fiscal consolidation can be expansionary on balance.
For the Club Med members of the euro zone - Italy, Spain, Greece, and Portugal - public-debt problems come on top of a loss of international competitiveness.
These countries had already lost export-market shares to low value-added and labor-intensive Asian economies.
Then a decade of nominal-wage growth that out-paced productivity gains led to a rise in unit labor costs, real exchange-rate appreciation, and large current-account deficits.
Cautious investors
The US and Japan might be among the last to face the wrath of the bond-market vigilantes: the dollar is the main global reserve currency, and foreign-reserve accumulation - mostly US government bills and bonds - continues at a rapid pace. Japan is a net creditor and largely finances its debt domestically.
But investors will become increasingly cautious even about these countries if the necessary fiscal consolidation is delayed.
The US is a net debtor with an aging population, unfunded entitlement spending on social security and health care, an anemic economic recovery, and risks of continued monetization of the fiscal deficit. Japan is aging even faster, and economic stagnation is reducing domestic savings, while the public debt is approaching 200 percent of GDP.
The US also faces political constraints to fiscal consolidation: Americans are deluding themselves that they can enjoy European-style social spending while maintaining low tax rates, as under President Ronald Reagan.
At least European voters are willing to pay higher taxes for their public services.
(The author is professor of economics at the Stern School of Business at NYU. Copyright: Project Syndicate, 2010.www.project-syndicate.org. Shanghai Daily condensed his article.)
But, in large part - and with a few exceptions in Central and Eastern Europe - emerging-market economies improved their fiscal performance by reducing overall deficits, running large primary surpluses, lowering their stock of public debt-to-GDP ratios, and reducing the currency and maturity mismatches in their public debt.
As a result, sovereign risk today is a greater problem in advanced economies than in most emerging-market economies. Indeed, rating-agency downgrades, a widening of sovereign spreads, and failed public-debt auctions in countries like the United Kingdom, Greece, Ireland, and Spain provided a stark reminder last year that unless advanced economies begin to put their fiscal houses in order, investors, bond-market vigilantes, and rating agencies may turn from friend to foe.
In the future, a weak economic recovery and an aging population are likely to increase the debt burden of many advanced economies, including the United States, the UK, Japan, and several euro-zone countries.
More ominously, monetization of these fiscal deficits is becoming a pattern in many advanced economies, as central banks have started to swell the monetary base via massive purchases of short- and long-term government paper.
Tricky business
Eventually, large monetized fiscal deficits will lead to a fiscal train wreck and/or a rise in inflation expectations that could sharply increase long-term government bond yields and crowd out a tentative and so far fragile economic recovery.
Fiscal stimulus is a tricky business. Policy makers are damned if they do and damned if they don't.
If they remove the stimulus too soon by raising taxes, cutting spending, and mopping up the excess liquidity, the economy may fall back into recession and deflation. But if monetized fiscal deficits are allowed to run, the increase in long-term yields will put a choke-hold on growth.
Countries with weaker initial fiscal positions - such as Greece, the UK, Ireland, Spain, and Iceland - have been forced by the market to implement early fiscal consolidation.
While that could be contractionary, the gain in fiscal-policy credibility might prevent a damaging spike in long-term government-bond yields. So early fiscal consolidation can be expansionary on balance.
For the Club Med members of the euro zone - Italy, Spain, Greece, and Portugal - public-debt problems come on top of a loss of international competitiveness.
These countries had already lost export-market shares to low value-added and labor-intensive Asian economies.
Then a decade of nominal-wage growth that out-paced productivity gains led to a rise in unit labor costs, real exchange-rate appreciation, and large current-account deficits.
Cautious investors
The US and Japan might be among the last to face the wrath of the bond-market vigilantes: the dollar is the main global reserve currency, and foreign-reserve accumulation - mostly US government bills and bonds - continues at a rapid pace. Japan is a net creditor and largely finances its debt domestically.
But investors will become increasingly cautious even about these countries if the necessary fiscal consolidation is delayed.
The US is a net debtor with an aging population, unfunded entitlement spending on social security and health care, an anemic economic recovery, and risks of continued monetization of the fiscal deficit. Japan is aging even faster, and economic stagnation is reducing domestic savings, while the public debt is approaching 200 percent of GDP.
The US also faces political constraints to fiscal consolidation: Americans are deluding themselves that they can enjoy European-style social spending while maintaining low tax rates, as under President Ronald Reagan.
At least European voters are willing to pay higher taxes for their public services.
(The author is professor of economics at the Stern School of Business at NYU. Copyright: Project Syndicate, 2010.www.project-syndicate.org. Shanghai Daily condensed his article.)
- About Us
- |
- Terms of Use
- |
-
RSS - |
- Privacy Policy
- |
- Contact Us
- |
- Shanghai Call Center: 962288
- |
- Tip-off hotline: 52920043
- 沪ICP证：沪ICP备05050403号-1
- |
- 互联网新闻信息服务许可证：31120180004
- |
- 网络视听许可证：0909346
- |
- 广播电视节目制作许可证：沪字第354号
- |
- 增值电信业务经营许可证：沪B2-20120012
Copyright © 1999- Shanghai Daily. All rights reserved.Preferably viewed with Internet Explorer 8 or newer browsers.
