Olivier Blanchard’s post yesterday on the IMF blog has caused quite a few ripples. (Read Duncan’s brilliant response for a much more thorough explanation of its significance than I’m going to try here). The point that’s aroused most comments is:
Third, financial investors are schizophrenic about fiscal consolidation and growth.
They react positively to news of fiscal consolidation, but then react negatively later, when consolidation leads to lower growth—which it often does. Some preliminary estimates that the IMF is working on suggest that it does not take large multipliers for the joint effects of fiscal consolidation and the implied lower growth to lead in the end to an increase, not a decrease, in risk spreads on government bonds. To the extent that governments feel they have to respond to markets, they may be induced to consolidate too fast, even from the narrow point of view of debt sustainability.
I should be clear here. Substantial fiscal consolidation is needed, and debt levels must decrease. But it should be, in the words of Angela Merkel, a marathon rather than a sprint. It will take more than two decades to return to prudent levels of debt. There is a proverb that actually applies here too: “slow and steady wins the race.”
Some journalists suggest that Blanchard has noticed something no one saw before; indeed, Blanchard’s post is about “four main lessons” learned in 2011. What a shame no-one pointed out the risk of lower growth scaring investors as much as deficits when the coalition was deciding on a harsh austerity programme.