By Simon Johnson
The G20 communiqué, released after the Toronto summit on Sunday, made it quite clear that most industrialized countries now have budget deficit reduction fever (see this version, with line-by-line comments by me, Marc Chandler and Arvind Subramanian). The US resisted the pressure to cut government spending and/or raise taxes in a precipitate manner, but the sense of the meeting was clear – cut now to some extent and cut more tomorrow.
This makes some sense if you think that the global economy is in robust health and likely to grow at a rapid clip – say close to 5 percent per annum – for the foreseeable future. With high global growth, it will matter less that governments are cutting back and unemployment will come down regardless. Taking this into account, the IMF is actually predicting (as cited prominently by the G20) that budget “consolidation” actually raise growth over a five-year horizon.
There is no question that some weaker European countries, such as Greece, Portugal, and Ireland, had budget deficits that were out of control. Particularly if they are to pay back all their foreign borrowing – a controversial idea that remains the conventional wisdom – these countries need some austerity. But what about those larger countries, which remain creditworthy, such as Germany, France, the UK, and the US? If these economies all decide to reduce their budget deficits, what will drive global growth? Continue reading