Fiscal Challenge Next For Policymakers

AuthorInternational Monetary Fund

But, in fact, new challenges will soon loom large, according to an IMF study titled "A Strategy for Renormalizing Fiscal and Monetary Policies in Advanced Economies." All agree that it is still too soon to unwind the policies put in place to fight the crisis. But policymakers need to start thinking about how to return their fiscal and monetary positions to a more normal state of affairs, now that recovery has taken hold.

In this interview, Carlo Cottarelli, head of the IMF's Fiscal Affairs Department, and José Vinals, head of the Monetary and Capital Markets Department, look at the fiscal and monetary consequences of the crisis, and discuss what might happen if they are left unaddressed.

IMF Survey online: What is the magnitude of the fiscal and monetary challenges facing governments as they prepare for life after the crisis?

Cottarelli: We already know that public debt is increasing rapidly, and will continue to do so in the near future. This is a result of revenue losses from the recession, as well as fiscal stimulus packages and intervention to stabilize the financial sector-actions that were necessary to support the economy during this global economic crisis. But it has meant an increase in the public debt of advanced countries that is unprecedented in peace time. And, to make matters worse, it comes on top of the medium-term pressure from demographics.

Between 2007 and 2014, public debt as a percent of GDP will go up by 40 percent of GDP in advanced countries, hitting an average of 120 percent of GDP. The situation is a bit better in emerging market economies but there we have other challenges. Adding to the problems for advanced economies is the aging of their populations. The demographic shock will hit these economies in earnest five years from now.

Vinals: On the monetary side, things are more manageable than on the fiscal side, even though we shouldn't underestimate the risks. I would say that 80 percent of the effort to ensure long-term sustainability needs to come from fiscal policy, with the remaining 20 percent left for monetary policy to deal with.

During the crisis, central banks basically did two things. They reduced interest rates to very low levels to support economic activity, and they used unconventional monetary policy tools to support the financial sector. As a result, they now face two related challenges.

First, they need to figure out when, and at what pace, to begin raising interest rates. Getting this timing right...

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