A highlight of the January 24th Fiscal Monitor release, concerning tightening fiscal policy:
Too rapid consolidation during 2012 could exacerbate downside risks
While deficits and debt in many advanced economies are high, the pace of consolidation projected in 2012 is considerable given the weak economic environment (see the January 2012 World Economic Outlook Update). Moreover, fiscal policy in many countries is already tighter with respect to the cycle than had been projected in the September 2011 Fiscal Monitor (Figure 3), partly because a lack of affordable additional financing is compelling some euro area economies to introduce new measures to attain existing headline deficit targets, rather than allowing the automatic stabilizers to operate.
Further declines in cyclically adjusted deficits could be undesirable not only from a growth perspective, but possibly from a market perspective as well. While smaller deficits and debt ratios do lead to lower borrowing costs, other things equal, advanced economies with faster output growth are also currently benefiting from lower spreads (Figure 4). This likely reflects in part concerns about the feasibility of fiscal consolidation and solvency in an environment of very weak growth. Thus, further tightening during a downturn could exacerbate rather than alleviate market tensions through its negative impact on growth.
