By Patrick Nolan, Chief Economist, Reform
One month ago on this blog Lucy Parsons and I argued for cutting government spending and for cutting soon. Arguments that a credible medium-term fiscal consolidation (spending cuts and tax rises) is necessary for a sustainable recovery have now been given extra force by John Lipsky, of the IMF, who has noted that:
"The projected government debt increase in the advanced economies is only partly due to discretionary fiscal stimulus. In fact, such measures has accounted for only about one-tenth of the projected debt increase. Thus, merely winding down the stimulus will not come close to bringing deficits and debt ratios back to prudent levels, considering the projected increases in health care of other entitlement spending.
"Addressing this fiscal challenge is a key near-term priority, as concerns about fiscal sustainability could undermine confidence in the economic recovery. Already in several countries with particularly high debt and deficits, sovereign risk premia have risen sharply, imposing strains for the countries affected and raising risks of possible broader spillovers. Over the medium term, large public debts could lead to high real interest rates and slower growth. We have estimated that maintaining public debt at its post-crisis levels could reduce potential growth in advanced economies by as much as ½ percentage point annually compared with pre-crisis performance."
