Deficits the Anglo-Saxon Way
Published in Le Monde
(France) on 9 May 2011
by (link to original)
The forecast for the long-term debt of the United States has become more bleak according to the ratings agency Standard & Poor's, devolving from "stable" to "negative" and coming as quite a shock. Yesterday, in some of the world’s advanced economies in a similar situation, the debate over public debt is being discussed again. The question no longer is whether it is time to reduce deficits; now it is how fast, how far and by what means.
In Berlin, German Chancellor Angela Merkel, like a disciplinarian mother, is acting with caution as the country's fiscal adjustment will be very gradual. The real tests are the United Kingdom and the United States, where deficits exceeded 10 percent of their gross domestic product in 2010.
In London, since coming to power David Cameron has had to give budgetary estimates to an independent Office for Budget Responsibility, thus closing any possibility of sly accounting procedures. Then he announced an annual structural effort of 1.5 percentage points, with a view to reduce the deficit to 3.5 percent of GDP in 2013. His bet is that this adjustment will stimulate growth rather than slow it down.
Ever since Ireland and Denmark showed the possibility 25 years ago, many governments are striving to carry out expansionary fiscal contractions. However, analysis of these almost miraculous cases shows that to cancel or even reverse the usual effects of recession, certain economic conditions would need to be present; a fall in household precautionary savings, a decline in the long-term interest rate and more expansionary monetary policy conducted by the Central Bank, thereby depreciating the exchange rate. Apart from these conditions, the budget adjustments are almost always costly in growth, confirmed recently by a study by the International Monetary Fund.
In the British case, one could not expect a drop in savings, as households are already heavily indebted, nor a decline in long-term rates, as they are already very low. Therefore, monetary policy has remained. Partly due to the soaring prices of commodities and low productivity gains of firms, inflation is higher than expected. The Bank of England expects it to be around 3 percent in early 2012, almost two percentage points above what was planned in 2010. As a consequence, it has become increasingly difficult to sustain growth, even though it has stalled. In the last two quarters it was zero. David Cameron's gamble has not paid off.
An Altogether Different American Approach
The American attitude was quite different. Confronted by unemployment, the Obama administration has delayed the fiscal adjustment in order to avoid influencing recovery. It even conducted in late 2010 a new stimulus (in part to offset the very restrictive policies of certain states). This was quite a defensible choice, nonetheless one that shows the lack of any serious reflection on the pace and pattern of future recovery. Clearly, the sense of urgency that influenced the European approach is not so widespread across the Atlantic.
A new phase was opened on April 8, with a last minute agreement in Congress between Republicans and Democrats to avoid a shutdown of the federal government’s administrative services. Such a closure would have resulted in 800,000 civil servants being laid off, along with the fiscal program prepared by Rep. Paul Ryan, which had been endorsed by the House of Representatives.
The Budget Debate is Under Way
However, the goals remain unclear and disagreement about the means remain solid. The Obama administration will proceed by a two-thirds reduction in spending, and a hike of one-third in levies. The Ryan plan shows a greater reduction in the deficit, but more importantly it plans cuts in social spending in order to get rid of what remains of the “welfare model” and to fund a tax cut.
The clash between the two sides suggests that a war of attrition has started in the United States. This common urgency is an affair of public finances, but each side wants to use the deficit to emphasize its own preferences. This is an unfair fight as those who want to reduce the state to the bare minimum are more willing to take the risk of bankruptcy than those who wish to preserve it. The Obama administration has already made concessions on tax cuts and spending cuts.
Once again, the United Kingdom and the United States serve as political and economic laboratories for the modern world. No doubt the results of these experiments that are taking place will be of great significance to all other advanced countries.
In Berlin, German Chancellor Angela Merkel, like a disciplinarian mother, is acting with caution as the country's fiscal adjustment will be very gradual. The real tests are the United Kingdom and the United States, where deficits exceeded 10 percent of their gross domestic product in 2010.
In London, since coming to power David Cameron has had to give budgetary estimates to an independent Office for Budget Responsibility, thus closing any possibility of sly accounting procedures. Then he announced an annual structural effort of 1.5 percentage points, with a view to reduce the deficit to 3.5 percent of GDP in 2013. His bet is that this adjustment will stimulate growth rather than slow it down.
Ever since Ireland and Denmark showed the possibility 25 years ago, many governments are striving to carry out expansionary fiscal contractions. However, analysis of these almost miraculous cases shows that to cancel or even reverse the usual effects of recession, certain economic conditions would need to be present; a fall in household precautionary savings, a decline in the long-term interest rate and more expansionary monetary policy conducted by the Central Bank, thereby depreciating the exchange rate. Apart from these conditions, the budget adjustments are almost always costly in growth, confirmed recently by a study by the International Monetary Fund.
In the British case, one could not expect a drop in savings, as households are already heavily indebted, nor a decline in long-term rates, as they are already very low. Therefore, monetary policy has remained. Partly due to the soaring prices of commodities and low productivity gains of firms, inflation is higher than expected. The Bank of England expects it to be around 3 percent in early 2012, almost two percentage points above what was planned in 2010. As a consequence, it has become increasingly difficult to sustain growth, even though it has stalled. In the last two quarters it was zero. David Cameron's gamble has not paid off.
An Altogether Different American Approach
The American attitude was quite different. Confronted by unemployment, the Obama administration has delayed the fiscal adjustment in order to avoid influencing recovery. It even conducted in late 2010 a new stimulus (in part to offset the very restrictive policies of certain states). This was quite a defensible choice, nonetheless one that shows the lack of any serious reflection on the pace and pattern of future recovery. Clearly, the sense of urgency that influenced the European approach is not so widespread across the Atlantic.
A new phase was opened on April 8, with a last minute agreement in Congress between Republicans and Democrats to avoid a shutdown of the federal government’s administrative services. Such a closure would have resulted in 800,000 civil servants being laid off, along with the fiscal program prepared by Rep. Paul Ryan, which had been endorsed by the House of Representatives.
The Budget Debate is Under Way
However, the goals remain unclear and disagreement about the means remain solid. The Obama administration will proceed by a two-thirds reduction in spending, and a hike of one-third in levies. The Ryan plan shows a greater reduction in the deficit, but more importantly it plans cuts in social spending in order to get rid of what remains of the “welfare model” and to fund a tax cut.
The clash between the two sides suggests that a war of attrition has started in the United States. This common urgency is an affair of public finances, but each side wants to use the deficit to emphasize its own preferences. This is an unfair fight as those who want to reduce the state to the bare minimum are more willing to take the risk of bankruptcy than those who wish to preserve it. The Obama administration has already made concessions on tax cuts and spending cuts.
Once again, the United Kingdom and the United States serve as political and economic laboratories for the modern world. No doubt the results of these experiments that are taking place will be of great significance to all other advanced countries.