The rise of counter-cyclical fiscal policy

September 21, 2013

A new IMF paper illustrates the changed realities of public macro policy. In times of negative shocks at the zero bound for interest rates, fiscal policy is best suited for stabilizing economies. Monetary policy takes on a support role, securing funding conditions and financial stability. As a side effect of this policy mix, sovereign risk has emerged as a major concern in advanced economies. This suggests that in times of recovery it will also be fiscal rather than monetary tightening that dampens economic growth and overheating.

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Japan’s new policies and the threat of rising yields

August 10, 2013

A large rise in bond yields would threaten Japan’s sovereign solvency and banking system stability (view post here). New IMF econometric estimates suggest that the Bank of Japan’s quantitative and qualitative easing should lift yields just modestly, as rising inflation expectations would be offset by large public bond purchases. Meanwhile, the deteriorating fiscal trajectory could cause a 400bps rise in JGB (Japanese Government Bond) yields by 2030.

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The full scope of U.S. federal government liabilities

July 12, 2013

James Hamilton from the University of California has published some scary numbers on growth and size of U.S. federal government liabilities that are not included in the official debt statistics. Their main constitutents are underfunded Social Security and Medicare liabilities, loan guaranties, and the federal deposit insurance. According to the Hamilton’s research ‘the total dollar value of notional off-balance-sheet commitments came to USD70 trillion as of 2012, or 6 times the size of the reported on-balance-sheet debt’.

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Monetary financing does not preclude sovereign default

June 27, 2013

Most investors take for granted that a government with access to monetary financing cannot be driven to default. However, a new paper by Corsetti and Dedola challenges this belief. Monetary financing incurs costs and, hence, preference for default and self-fulfilling confidence crises are possible. Necessary conditions to rule out self-fulfilling crises include credible caps on government borrowing rates, the ability of the central bank to issue default-free, interest-bearing, and non-inflationary “reserves” (rather than cash), and full coverage of central bank losses by the state budget.

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China’s augmented fiscal challenge

June 15, 2013

A very short note by the IMF in the run-up of China’s latest Article IV consultations suggests that the country’s fiscal position is much weaker than official statistics suggest. The augmented fiscal deficit of the country, including local government off-budget funding, is estimated to have climbed to around 10% of GDP.

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Useful summary of fiscal developments from the IMF

April 20, 2013

The IMF Fiscal Monitor provides the usual insightful global summary of public finance trends. It reveals significant progress in the reduction of structural deficits in the developed world, at the price of drastic fiscal tightening that will aggravate further this year. However, public debt ratios have yet to peak and their current levels bode ill for future growth and government shock-absorption capabilities. A major implicit concern is Japan, where the structural deficit has not been reduced and both net and gross debt have been soaring.

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The unpleasant dynamics of fiscal tightening

March 12, 2013

A new IMF paper argues that the short-term negative feedback of fiscal consolidation on economic growth is particularly strong at present, because of lending constraints, limits to monetary easing, and the global scope of restriction. As a result, fiscal tightening in today’s developed countries may, by itself, initially raise debt ratios over and above their trajectory without fiscal action. While the effect may not be lasting, it can lead to dangerous dynamics if financial markets fixate on debt dynamics and governments engage in multiple rounds of tightening.

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Discrediting euro area crisis-driven austerity

February 23, 2013

Paul de Grauwe and Yuemei Ji have produced disarmingly simple charts that show why the euro area’s 2010-12 crisis response is being discredited. Essentially they illustrate that (i) market conditions rather than fundamentals have driven large absolute changes of credit spreads, (ii) fiscal tightening has been a mechanical response to credit spreads, and (iii) austerity has largely been self-defeating. Such evidence of failed excessive austerity dovetails anti-euro populism, underpinning euro area policy change towards more accommodation.

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The tipping point in the Japanese government bond market

December 19, 2012

Low government bond yields (0.76% for 10-year maturity at present) allow Japan to preserve debt sustainability despite a gross debt-to-GDP ratio of over 220%. However, a working paper published (a while ago) by Takeo Hoshi and Takatoshi Ito argues that a tipping point may be ahead. Thus far yields have been kept low thanks to large domestic savings with a strong home bias and low returns in other assets. Under current trends, however, the nominal public debt stock will have reached the overall level of private sector financial assets by 2016. Meanwhile, attempts to reflate assets and stimulate the economy will raise the opportunity costs of holding government debt.

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History of public debt reduction

October 27, 2012

In its October 2012 World Economic Outlook the IMF presented a 135-year study on public debt reduction strategies. It points out that debt stocks of over 100%  of GDP have not been uncommon and do not normally lead to restructuring. Indeed, in the developed world out of 26 episodes only 3 ended in default (Germany and Greece). Successful debt-reduction strategies typically use growth-enhancing and easy monetary policies.

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