Public Finances Are on the Mend, but No Clean Bill of Health


By Sanjeev Gupta and Martine Guerguil

(Version in Español FrançaisРусский中文, and 日本語)

We’ve had a spate of good news on the economic front recently. Does this mean that we are finally out of the fiscal woods? According to our most recent Fiscal Monitor report, not yet, as public debt remains high and the recovery uneven.

First, the good news. The average deficit in advanced economies has halved since the 2009 peak. The average debt ratio is stabilizing. Growth is strengthening in the United States and making a comeback in the euro area, and should benefit from the slower pace of consolidation this year. Emerging markets and developing countries have maintained their resilience, in part thanks to the policy buffers accumulated in the pre-crisis period. Talks of tapering in the United States have left a few of them shaken, but not (quite) stirred.

But there is still some way to go. The average debt ratio in advanced economies, although edging down, sits at historic peaks, and we project it will still remain above 100 percent of GDP by 2019 (Chart 1). The recovery is still vulnerable to several downside risks, including those stemming from the lack of clear policy plans in some major economies. The recent bouts of financial turmoil have raised concerns that the anticipated tightening of global liquidity could expose emerging markets and low-income countries to shifts in investor sentiment and more demanding debt dynamics.

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Global Financial Stability: Beginning To Turn The Corner


GFSRBy José Viñals

(Version in  EspañolFrançaisРусский中文 and 日本語)

 

Global financial stability is improving—we have begun to turn the corner.

But it is too early to declare victory as there is a need to move beyond liquidity dependence—the central theme of our report—to overcome the remaining challenges to global stability.

Progress

We have made substantial strides over the past few years, and this is now paying dividends.  As Olivier Blanchard discussed at yesterday’s press conference of the World Economic Outlook, the U.S. economy is gaining strength, setting the stage for the normalization of monetary policy.

In Europe, better policies have led to substantial improvements in market confidence in both sovereigns and banks.

In Japan, Abenomics has made a good start as deflationary pressures are abating and confidence for the future is rising. And emerging market economies, having gone through several recent bouts of turmoil, are adjusting policies in the right direction.

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Where Are Real Interest Rates Headed?


By Andrea Pescatori and Davide Furceri

In the past few years, many borrowers with good credit ratings have enjoyed a cost of debt close to zero or even negative when it is adjusted for inflation. In other words, real interest rates, and, thus, the real cost of borrowing, have been about zero. The rate decline has been global—average global 10 year real rate declined from 6 percent in 1983 to almost zero in 2012 (see figure).

Because the recent interest rate declines reflect, to a large extent, weak economic conditions in advanced economies after the global financial crisis, some reversals are likely as these economy return to a more normal state.

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The Trillion Dollar Question: Who Owns Emerging Market Government Debt


By Serkan Arslanalp and Takahiro Tsuda

(Version in EspañolFrançaisPortuguêsРусский中文 and 日本語)

There are a trillion reasons to care about who owns emerging market debt.  That’s how much money global investors have poured into in these government bonds in recent years —$1 trillion.  Who owns it, for how long and why it changes over time can shed light on the risks; a sudden reversal of money flowing out of a country can hurt.  Shifts in the investor base also can have implications for a government’s borrowing costs.

What investors do next is a big question for emerging markets, and our new analysis takes some of the guesswork out of who owns your debt.   The more you know your investors, the better you understand the potential risks and how to deal with them.

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Once And For All—Why Capital Levies Are Not The Answer


Mick Keen By Michael Keen

(Version in EspañolFrançais and  中文)

Holy grail

Last night, when you went to bed, you left $40 on the kitchen table. When you woke up this morning, you found only $30—and a note from the government saying, “Thank you very much, we took $10 as a tax payment.” This is, of course, extremely irritating. To an economist, however, it’s close to an ideal form of taxation, since there is nothing you can now do to reduce, avoid, or evade it—the holy grail of what economists call a non-distorting tax.

(This doesn’t mean that you won’t react in some way. Being worse off, you may now work a bit more, or save a bit less. But any other tax raising $1 would make you even worse off, because it would change relative prices (a tax on your earnings would make working less attractive, for instance), and so take your choices even further from those you would make in the absence of taxation.)

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Still Some Hurdles On The Fiscal Path


Martine GuerguilBy Martine Guerguil

(Versions in 中文, Français日本語, Русский, and Español)

Five years into the crisis, the fiscal landscape remains challenging. On the positive side, deficit-cutting efforts and the first signs of recovery reduced the fiscal stress felt in many advanced economies; but debt ratios often remain at historical peaks. At the same time, slowing growth and rising borrowing costs, combined with unabated demands for improved public services, puts pressure on government budgets in emerging market economies.

So we created  an index of ‘fiscal difficulty’ that shows the biggest challenge ahead for advanced economies is to maintain budget surpluses until debt ratios return to lower levels.  We expect this will take several years.

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Taming government debt—it can be done, but it ain’t easy


By Helge Berger and  Justin Tyson

Sooner or later, and one way or the other, government debt in advanced economies will have to come down from the record levels reached in the wake of the global economic and euro area crises. Figure 1.Dev in Gross Debt and Structural Balance in Adv Economies There is no magic number for how much sovereign debt an economy can shoulder. And, as bringing down debt by cutting government spending or raising taxes comes at the risk of reducing growth and employment in the short term, there are arguments to not proceed too hastily. But eventually debt will have to be put back on a downward path in many countries. This will help rebuild fiscal buffers and cope with the costs of aging. So, what should governments do?

Our new analysis takes a closer look at the historical record and key trade-offs.  The bottom line: it is possible to reduce debt when growth is low. Ultimately perseverance should pay off.

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Preventing The Next Catastrophe: Where Do We Stand?


David RomerGuest post by David Romer
University of California, Berkeley, and co-host of Rethinking Macro II: First Steps and Early Lessons

(Versions in 中文, 日本語, and Русский)

As I listened to the presentations and discussions, I found myself thinking about the conference from two perspectives. One is intellectual: Are we asking provocative questions? Are interesting ideas being proposed? Are we talking about important issues? By that standard, the conference was very successful: the discussion was extremely stimulating, and I learned a great deal.

The second perspective is practical: Where do we stand in terms of averting another financial and macroeconomic disaster? By that standard, unfortunately, I fear we are not doing nearly as well. As I will describe, my reading of the evidence is that the events of the past few years are not an aberration, but just the most extreme manifestation of a broader pattern. And the relatively modest changes of the type discussed at the conference, and that in some cases policymakers are putting into place, are helpful but unlikely to be enough to prevent future financial shocks from inflicting large economic harms.

Thus, I believe we should be asking whether there are deeper reforms that might have a large effect on the size of the shocks emanating from the financial sector, or on the ability of the economy to withstand those shocks. But there has been relatively little serious consideration of ideas for such reforms, not just at this conference but in the broader academic and policy communities.

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Rethinking Macroeconomic Policy


blanchBy Olivier Blanchard

(Versions in عربي中文FrançaisРусский, and Español)

The IMF has just hosted a second conference devoted to rethinking macroeconomic policy in the wake of the crisis. After two days of fascinating presentations and discussions, I am certain of one thing:  this is unlikely to be our last conference on the subject.

Rethinking and reforms are both taking place.  But we still do not know the final destination, be it for the redefinition of monetary policy, or the contours of financial regulation, or the role of macroprudential tools. We have a general sense of direction, but we are largely navigating by sight.

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How to Sustain Recent Financial Gains: Fix Old Risks and Meet New Challenges


GFSRBy José Viñals

(Versions in  عربي ,日本語Español)

Policymakers’ decisive actions  since our last report in October have increased global financial stability by reducing acute risks.

  • In the euro area, policymakers averted a financial cliff.
  • In the United States, the worst fears of the fiscal cliff had been averted, while balance sheet repair and continued monetary easing have supported financial markets and the recovery.
  • In Japan, new policy initiatives have caught the imagination of global markets that Japan may finally leave its deflation valley.

But our latest Global Financial Stability Report concludes that improved financial markets and gains in financial stability will not be sustained—and new risks are likely to emerge—unless policymakers address key underlying vulnerabilities.

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