An analysis of fiscal adjustment strategies (Policy Brief 287 - September 2012)
In terms of economic policies, one of the consequences of the financial crisis that began in 2007 was to confirm the value of fiscal policy as a countercyclical instrument. However, this strategy now seems subject to paradoxical injunctions.
- An analysis of fiscal adjustment strategies
After the implementation of major fiscal stimulus plans in 2008 and 2009, the trend is clearly leaning to deficit reduction to deal with the rise in public debt and the risk of interest rate increases. However, since 2011 and especially 2012, economists have been questioning the pace of adjustment policies given their impact on the growth perspectives.
To take the full measure of this controversy, we should take into account the specific characteristics of the current period, particularly in light of prolonged private deleveraging. In this context, an overly swift reduction in deficits can have disadvantages. This, however, does not call into question the long-term objective of public debt reduction to notably avoid a loss of confidence in the ability of governments to control their public finances and, consequently, a rise in interest rates.
History has shown that the absorption of government debt, notably the debt spawned by World War II, was spread over at least one decade and supported by negative real interest rates and strong growth. These two levers were activated via several financial regulation instruments and significant public investment which could be employed in the current fiscal adjustment strategies in Europe.
Summary
- The specific role of public debt in private deleveraging episodes
- Heightened effectiveness of fiscal polivies and disadvantages of overly swift adjustments during periods of low activity
- Complementary channels to reduce public debts
- Authors: Thomas Brand, Economy Finance Department .
Keywords: Fiscal policy; fiscal stimulus; fiscal multiplier; adjustment; neokeynesian model.