How to hit three birds with one stone: growth, fiscal sustainability and

global rebalancing

Paul van den NoordOECD

Objectives

Many OECD countries start from a situation of severe macroeconomic imbalance:

• Large output gaps• Severe fiscal imbalances: already increased

debt + budget balances well below levels consistent with stabilising debt

• World current account balances rising again

How should policies respond?

Tools

• Economic Outlook 87 projections to 2011 + stylised “Baseline scenario” to 2025 generated with “mechanical” MTB model (OECD WP 482)

• Simulations of alternative scenarios with the OECD Global model (OECD WP No 768) considering different combination of policiesFaster fiscal consolidation Faster consolidation + structural reform

OECD potential output reduced after crisis

90

100

110

120

130

140

150

2000 2005 2010 2015 2020 2025

Index 2005 = 100.0

Post-crisis potential

GDP

Pre-crisis potential

Key fiscal & x-rate assumptions

•Fiscal consolidation +½% GDP pa in the underlying primary balance for as long as it takes to stabilise debt.

•When gross government debt > 75% of GDP then long-term interest rates increase by 4 bp per % point increase in the government debt-to-GDP ratio (Japan an exception)

•Exchange rates unchanged in real terms for OECD countries, for other countries based on Balassa-Samuelson effect

Large increase in government debt

• Consolidation over entire period for US, Japan, UK, Ireland, but still ..

• OECD government gross debt stabilises at level +44% pt relative to pre-crisis. 10 countries gross debt > 100% of GDP (only 3 before the crisis)

• Upward pressure on long-term interest rates due to higher debt.

0

50

100

150

200

250

OECD USA Japan Euro area

Gross government debt (as % of GDP)

2007

2010

2025

Global current account imbalances still large

0

20

40

60

80

100

120

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

Absolute sum, expressed as an index, 2007 =100

Faster consolidation scenario

•Sufficient fiscal consolidation across OECD countries to reduce government debt to the pre-crisis levels by 2025 (except Japan where only ½ of the increase in debt is reversed)

•Fall in long-term interest rates due to lower government indebtedness occurs immediately as fiscal consolidation plans are assumed to be credible for financial markets

•Consolidation hurts in short-term, multipliers of order ½ to 1 (bigger if no support from monetary policy), but longer term benefits through lower interest rates and cost of capital.

Main results

• Consolidation reduces short-term growth (multipliers ½ to 1, bigger if mopo constrained). But faster pace of consolidation than baseline possible after 2011/12 still consistent with closing of GAP.

•Growth and output higher in the medium term

•Important cross country differences coming from size of fiscal consolidation + level of interest rates (Japan)

•Limited exchange rate adjustment helps reduce the deficit in the US and surplus in non OECD Asia but this is compensated by wider imbalances elsewhere

=> Fiscal consolidation is necessary but not sufficient to get balanced long-term growth

Fiscal consolidation scenarioWorld GDP growth (%) OECD fiscal balance (% of GDP)

OECD gross government debt (% of GDP) Global imbalances (%of world GDP)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2011-2015 2016-2025

baseline + consolidation

0

20

40

60

80

100

120

140

2015 2025

baseline

+ consolidation

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

2011-2015 2016-2025

baseline

+ consolidation

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

2011-2015 2016-2025

baseline

+ consolidation

Additional structural reform• Non-OECD Asia: Lower net saving (3% of GDP)+

rebalancing of demand – Higher social spending in Asia– Deepening of financial markets & improving business

environment– Looser fiscal stance in non Asia OECD where possible– Additional RMB appreciation (20%)

• US: Higher private saving (1% of GDP)+rebalancing of demand

– Improved financial regulation– Tax reform– Additional $ depreciation (10%)

• Euro area: higher potential growth (mainly thru NAIRU)

– Lower product and labour market regulation

• Japan: lower net private saving (2% of GDP) – Lower product market regulation– Corporate sector reform– Deepening of financial markets

Main results• Japan: exit deflation more durably, higher

nominal output growth and a further reduction in debt ratio

• China: Short-term inflation pressures better contained. Lower surplus

• Euro area: stronger growth• United States: lower current account deficit• Global imbalances lower and put on a declining

path. • Higher medium-term level of output (by 2-3%

in 2025) and growth rate in the OECD

A more balanced scenario

A more balanced scenario

A more balanced scenario

A more balanced scenarioWorld GDP growth (%) OECD fiscal balance (% of GDP)

OECD gross government debt (% of GDP) Global imbalances (%of world GDP)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2011-2015 2016-2025

baseline + consolidation +consolidation & reforms

0

20

40

60

80

100

120

140

2015 2025

baseline

+ consolidation

+consolidation & reforms

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2011-2015 2016-2025

baseline

+ consolidation

+consolidation & reforms

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

2011-2015 2016-2025

baseline+ consolidation+consolidation & reforms

Conclusions

• Fiscal consolidation, necessary but not sufficient. It could delay recovery, but shouldn’t derail it.

• Structural reform & exchange rate adjustment also necessary for balanced medium-term growth.

• More on timing, instruments of fiscal consolidation in the 18 November OECD Economic Outlook.