The Looming Necessity of Fiscal Consolidation

The Looming Necessity of Fiscal Consolidation

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Welcome to the first installment of Bartlett’s Notations,  my daily compendium of important  studies, papers and reports on the  economy and fiscal issues that haven’t  received as much attention as I think they deserve.  The looming necessity of fiscal consolidation – i.e. deficit reductions -- after the huge run-up in public debt in all major countries is encouraging new research on how and why such consolidation is necessary and how best to achieve it. An emerging theme is that consolidation efforts concentrating on spending cuts are more likely to be successful and are no more difficult to achieve politically than raising revenues.

June 3 column by Trinity College, Dublin, economist Kevin O’Rourke warned that governments must balance the need for fiscal austerity with the need to maintain growth: “Markets want debts to be kept under control, but in the long run they also want tolerable levels of unemployment, since this is what democracy demands of governments. In our current circumstances, this means economic growth. Too much austerity at the wrong time will not make governments more credible, but less so.”

Also this month, economist John Makin  explained why a public debt level exceeding 100% of GDP creates a dynamic that tends to cause a fiscal crisis: when the effective rate of interest on the debt exceeds the GDP growth rate it becomes impossible for a country to grow or inflate its way out of its debt. Moreover, efforts to cut spending at that point will slow growth more than interest on the debt falls, thus making the debt problem worse.

A May 31 Organization for Economic Cooperation and Development paper looks at the political economy of fiscal consolidation. It finds that episodes of fiscal consolidation nearly always follow a crisis of some kind. Inflation, high interest rates and sharp currency declines are all correlated with fiscal consolidation. The paper goes on to describe some of the factors that helped nations achieve and maintain consolidation, such as changes in budget rules.

On May 29, economists Alberto Alesina, Dorian Carloni, Giampaolo Lecce examined the electoral consequences of fiscal tightening and found that voters are less likely to punish politicians for cutting spending or raising taxes than commonly believed: “The bottom line is that it is possible for fiscally responsible governments to engage in large fiscal adjustments and survive politically. Moreover, acting on the spending side is no more costly that [sic] doing on the tax side.”

On May 27, Timothy Flynn of the House Budget Committee Republican staff pulled together a laundry list on why rising debt levels are bad, citing a variety of recent analyses.

On May 26, liberal economist Marshall Auerback pushed back against deficit hawks, arguing that full employment is more important than fiscal stability.

On May 25, economist Pete Davis pointed to this December 16, 2009 Government Accountability Office report on the paucity of presidential rescission requests since 1974 to argue that the proposal for enhanced rescission authority requested by the White House on May 24 would have little impact on total spending. (A rescission of a budget procedure is where the president asks Congress to rescind spending that has previously been approved.)

A May 21 report from JPMorgan Chase took a surprisingly benign view of the near-term budget deficit, viewing almost all of it as cyclical or resulting from one-off stimulus spending. It estimates that the primary deficit (nominal deficit minus interest payments) will fall from 8.9% of GDP this year to 1.5% by 2015.

    ●  The CBO’s latest estimate, published on May 27, shows the portion of the deficit that results solely from the economicdownturn—the cyclical element—will fall from $403 billion in 2011 to just $29 billion in 2014. At that point, the $433 billion deficit will be entirely structural and will not fall further without legislated budget cuts or tax increases.

An April 14 study from Goldman Sachs reviewed every major fiscal correction in the OECD since 1975 and finds that those focusing on expenditure reduction have been far more successful than those that are tax-driven.

Bruce Bartlett is an American historian and columnist who focuses on the intersection between politics and economics. He has written for Forbes Magazine and Creators Syndicate, and his work is informed by many years in government, including as a senior policy analyst in the Reagan White House. He is  the author of seven books including the New York Times best-seller, Impostor: How George W. Bush Bankrupted America and Betrayed the Reagan Legacy (Doubleday, 2006).

Bruce Bartlett’s columns focus on the intersection of politics and economics. The author of seven books, he worked in government for many years and was senior policy analyst in the Reagan White House.