Global fiscal stability teeters on the edge of interest rates. That message resonates clearly from the IMF’s latest annual Fiscal Monitor report published on Tuesday. Even a small rise in borrowing costs would prevent debt levels in the United States, Britain and France, among others, from stabilizing by 2017. Japan's and Spain’s won’t steady anyway. But the fund’s own positions on austerity and low rates are sending a different – and wrong – message.
General government debt in advanced economies will increase by an additional five percentage points by 2013, according to the report. Meanwhile, some four out of five of these countries are continuing to show a primary budget deficit, before accounting for the effect of interest payments. The stabilization anticipated by 2015, however, is contingent on a very favourable differential between interest rates and economic growth. If it widens even modestly, however, either from rate rises or renewed recession, the debt in some nations won’t even stabilize two years later.
The U.S. Federal Reserve expects to keep rates ultra-low for several more years. But if certain historical patterns persist, rising inflation could get in the way of that policy, force interest rates and economic growth to deviate from the desired trajectories and cause debt levels to keep rising. Given the events in Europe over the past few years, it isn’t hard to imagine investor confidence fleeing, leaving deficits almost impossible to finance. The possible advent of an anti-austerity government in France and an IMF forecast for Japan to have gross debt of 241 per cent of GDP next year look like potential touch-points in such a scenario.
The IMF has traditionally taken a hard line on government deficits, for example, forcing massive deflation on Asian economies in the 1990s. It is currently more relaxed, saying “in countries with fiscal space, the pace of near-term adjustment plans should be calibrated to avoid undue pressure on activity and employment.” That may sound fine, but “fiscal space” can be squeezed quickly. The downside risks of a debt crisis are far greater than any benefit from delaying austerity.