by Don Alexander, MBA
Associate, RSD Solutions Inc.
The International Monetary Fund noted in their latest Fiscal Monitor (April 2012) that fiscal risks still remain elevated; although there are signs that in some key respects they are less acute than six months ago. Past efforts with fiscal consolidation are beginning to bear fruit, particularly when buttressed by credible institutional commitments.
Policymakers face the dilemma of how best to respond to slackening global activity and continued financial volatility without losing medium-term adjustment needs. The main conclusions of the report include: 1. countries remain vulnerable to unexpected external shocks with limited margin for policy errors, 2. the negative impact of fiscal adjustment remains large and usually unavoidable, 3. gross government debt ratios may overstate short-term problems from the accumulation of assets on central bank balance sheets, and 4. some countries still have short-term flexibility without having it in the long-term and 5. Some countries are implementing fiscal rules.
The use of fiscal rules, while not a substitute for specific long-term adjustment plans, can help build confidence and facilitate the establishment of a political consensus on fiscal policy. Second-generation fiscal rules are typically more complex than earlier versions, providing greater flexibility to respond to economic cycles but with more-binding corrections for past deviations. As such, they also raise significant enforcement and monitoring challenges.
Debt ratios in many advanced economies are at historic levels and rising, borrowing requirements remain large, financial markets are in a state of alert, and downside risks to the global economy predominate. They are projected to decline by 1% of GDP in 2012 and slightly more in 2013.
This is appropriate, although some countries with fiscal space may slow the pace of adjustment to reduce downside risks or avoid deteriorating economic conditions. IMF policymakers examine the concept of fiscal space, or the scope that policymakers have to calibrate the pace of fiscal adjustment without undermining fiscal sustainability.
In this uncertain environment, the challenge for fiscal policy is to find the right balance between exploiting short-term space to support the fragile recovery and rebuilding longer-term space by advancing fiscal consolidation. Policymakers have to balance the risk of reducing budget deficits, the overhang and potential reduction of central bank balance sheet and the need to return many advanced countries to more sustainable debt levels.
For more on this, follow the link: www.imf.org/external/pubs/ft/fm/2012/01/fmindex.htm
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