Fiscal adjustment: Too much of a good thing?

by Carlo Cottarelli

Vox
February 8, 2012

Almost everyone agrees that the fiscal accounts of several advanced economies are in a pretty bad shape and need to be strengthened. But how rapid should the adjustment be in the present circumstances? At times over the last couple of years the IMF called on countries to step up the pace of adjustment when we thought they were moving too slowly. This column says that in the current environment, some might be going too fast.

Almost everyone agrees that the fiscal accounts of several advanced economies are in a pretty bad shape and need to be strengthened. But how rapid should the adjustment be in the present circumstances? The IMF has argued for some time that the public-debt ratios should be brought down to safer levels through a gradual and steady process (see Blanchard and Cottarelli 2010). Doing too little or doing too much both involve risks. Not enough fiscal adjustment could lead to a loss of market confidence and a fiscal crisis, potentially killing growth; but too much adjustment will hurt growth directly.

At times over the last couple of years the IMF called on countries to step up the pace of adjustment when we thought they were moving too slowly.

Instead, in the current environment, I worry that some might be going too fast.