by Don Alexander, MBA
Associate, RSD Solutions Inc.
As we noted in our blog dated Feb. 24th on Risk Washing, managers/companies (policymakers) often cloak themselves with conventional risk management measures to produce results. However, there are times when conventional policies may not produce the desired result.Giancarlo Corsetti & Gernot Mueller discuss the application of fiscal austerity and when it might not produce desired results in a VOXEU piece called Has Austerity Gone Too Far, Feb. 20th,
Numerous countries facing debt problems have recently embarked on fiscal tightening. Yet it is not clear if it is a cure or a self-defeating strategy. The measures adopted so far are not seen as sufficient to stabilize market concerns about debt sustainability.
The weak output growth caused by fiscal austerity when combined with a renewed economic slowdown may itself fuel market doubts about government solvency. Higher funding costs, combined with lower activity, might thus worsen fiscal positions, defeating the very purpose of the initial tightening measures. The evidence suggests that where sovereign risk is high, fiscal tightening remains an important avenue to reduce deficits while limiting the cost to economic activity.
There are cases in which monetary policy is constrained in supporting aggregate demand and governments should avoid immediate fiscal contraction while committing to a credible medium-term deficit reduction. The authors note the fundamental importance of sovereign risk for macroeconomic stability. The problem is that countries experiencing debt and sovereign-risk issues are more vulnerable to adverse borrowing conditions in the broader economy.
This has three implications: (1) fiscal multipliers are lower when sovereign risk is high; (2) pro-cyclical fiscal policy may help macroeconomic stability; and (3) there’s a need for policies beyond austerity. The authors suggest policies to counter the output costs of fiscal austerity. One way is to reduce the impact of sovereign risk on private-sector borrowing conditions. Options include: existence of strongly capitalized banks; policies that may offset higher sovereign risk premia; and the availability of extra funds to provide liquidity.
Fiscal austerity is a necessary condition to bring down deficits and reduce sovereign risk. However, in certain cases of high sovereign risk, austerity may have unintended consequences and other options are needed to contain sovereign risk premia and/or limit the impact on broader economic conditions.
As with risk management, conventional policies may not always produce the desired results. Do you have this problem?
For more on this follow the link: www.voxeu.org/index.php?q=node/7642
No comments:
Post a Comment