Wednesday, October 10, 2012

Coordinated Fiscal Contraction

The new issue of the IMF fiscal policy monitor is out. As usual, a great reading to understand the state of fiscal policy in the world. There are many issues I could highlight from the report but here is one that caught my attention: below is a summary of what fiscal policy has been doing since 2009.

The red dot in the chart represents the change in the cyclically-adjusted primary balance as a % of potential GDP in advanced economies during the period 2009-13. This variable is the best way to capture discretionary fiscal policy, as the balance is adjusted by the cycle and we use potential output (instead of output) to avoid the ratio to be influenced by cyclical variations in GDP (the blue and yellow columns just show how much of the action comes from expenditure cuts of increases in taxes).

Not only we see a majority of countries reducing budget balances (a coordinated fiscal policy contraction) but the numbers are extremely large. Greece is an outlier (16.3%), but many others are large (Spain, Portugal and Ireland close to 10%), the UK around 7% and a significant number of countries around 4%.

How this coordinated fiscal policy contraction is affecting the pace of the recovery (or the likelihood of another recession) depends on your views on the fiscal policy multipliers (see my previous post), but what remains a fact is that the amount of coordinated fiscal policy contraction during the current cycle is  very large and I doubt that we can find a similar experience in any of the previous recoveries.

Antonio Fatás