Financial markets could turn on the US and Japan if these two nations do not produce credible medium-term plans to reduce their fiscal deficits, a senior IMF official warned yesterday.
Carlo Cottarelli, director of the IMFs fiscal affairs department, told Emerging Markets that such a loss of credibility is a low probability, but if it happens, it will be a big problem a big mess. It is something that governments should try to avoid.
Cottarelli was elaborating on a warning in the IMFs latest Fiscal Monitor that the speed and severity with which financial pressure spread within the euro area should serve as a cautionary tale to Japan and the United States.
The credibility of Japan and the US could suddenly weaken if sufficiently detailed and ambitious plans to reduce deficits and debts are not forthcoming, the Fiscal Monitor added.
A range of different fiscal approaches is needed across the advanced economies to ward off possible crises, Cottarelli said although he gave a generally clean bill of fiscal health to emerging economies.
Most important, for the US and Japan in particular, is to have a medium-term plan that clarifies how the public debt-to-GDP ratio will be first stabilized and then reduced," he said.
In the US, the plan unveiled by US President Barack Obama is important, but there is not yet political consensus on it. There is a need for Congress to reach agreement.
Japan needs more ambitious fiscal consolidation, Cottarelli said. It should aim to stabilize its debt-to-GDP ratio by the middle, rather than the end, of the decade, and should be more aggressive in raising the national consumption tax.
Japan is protected from fiscal crisis to some extent by the fact that 95% of its government debt is held domestically, while the US is cushioned by the fact that less than half of its Federal debt is sold freely, as well as by the dollars reserve currency status. But such safeguards are not set in stone, Cottarelli noted.
Asked about concerns over the pace at which some countries are implementing fiscal tightening, Cottarelli said that some countries such as the troubled eurozone economies (Greece, Portugal, Italy and Spain) have no choice at the moment, because of market pressure.
Other countries, like Canada, the UK or Germany, are fine in terms of the fiscal adjustments they are planning. But in case there were to be negative shocks, they could allow automatic stabilizers to operate and they could also slow down the pace of adjustment.
Then there are a few, including the US, which even in the absence of additional measures would tighten their fiscal accounts too much in 2012.
If they don't do anything [to expand stimulus], the deficit will decline very, very rapidly because the stimulus measures introduced in the past will disappear. Without adjustment, the decline of fiscal deficit will be more than two percentage points of GDP, which we think is too large and could damage the economic recovery.Fiscal accounts in emerging economies are in much better shape than those in the advanced countries, he said.