Gordon Brown, the British Prime Minister, is in big trouble. It turns out that a medium-sized industrialized democracy like the UK can be run in pretty much the same way as a traditional emerging market – fiscal irresponsibility (cyclically-adjusted general government deficit now forecast at 12.2 percent of GDP for 2010) gives you a boom for a while, but the eventual day of reckoning is economically painful and politically disastrous. If you also need to deal with an oversized bubble finance sector, that makes the adjustment even more painful.
It is of course sensible to use fiscal stimulus to offset a fall in private demand, and to some extent this can be effective – with a lag. But if you lose control over public spending and borrow too heavily (helped by the fact people like to hold your currency), it ends badly.
From the beginning, we’ve expressed concern here that the entire Summers Plan was overweight fiscal, i.e., not enough resources for recapitalizing banks and addressing housing directly (for the context of this assessment, see our full baseline view). Back in December/January, this was a strategic choice worth arguing about; now it’s a done deal and following the (very) limited recapitalization outcome of the bank stress tests, it seems likely that household and firm spending will remain sluggish. If that is the case, the Administration’s logic implies throwing another big fiscal stimulus into the mix – and the Summers’ team is already preparing the groundwork.
The IMF is now warning against the risks of this approach, albeit using carefully worded language.
In a 20 minute presentation at the Carnegie Endowment on April 30th, Olivier Blanchard made statements that are striking coming from the IMF’s chief economist (webcast; slides; fan chart for growth forecast).
Remember that the IMF is the custodian of the official consensus on the global macroeconomy and financial system – so if their baseline view is in the same ballpark as your stress test results, the IMF is telling you to be more pessimistic. They can nudge a powerful government, like the US, in a particular direction – but not too hard in public on a politically sensitive issue such as fiscal sustainability (or lack of capital in the banking system).
Blanchard is clear that the IMF sees the need to “fix the financial system”. He also assumes this will happen slowly, and indicates this slowness is not helpful for the recovery. The implication is that the US will resort to even more fiscal stimulus if the recovery proves sluggish – look at his slide on p.7, dealing with fiscal sustainability (this is discussed at about minute 11 in the webcast). This presentation of country averages is an IMF way of talking about difficult country-specific situations without being indelicate – and the point here is to push you to think about the nonconvergent (red…) debt path with contingent liabilities (i.e., what the government is committing to the banking system without acknowledging the fact); the yellow path for debt, with slow economic growth, also does not look good.
Blanchard doesn’t show the US debt forecast – presumably that would be indelicate. But at the 13:13 mark, he warns that the US may be heading in the same fiscal direction as Ireland (!), “the [US budget] numbers are not great but we hope that something will be done.”
The content and timing of that ”something” is left vague – add your suggestions below.
By Simon Johnson