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Fiscal consolidations:
comments
BoF and Bd’I Conference
11 June 2010
Seppo Honkapohja, Bank of Finland
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
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Introduction
 Current public debt concerns are a third stage in the
global financial crisis.
• banking crisis,
• recession and
• public debt crisis.
 Public debt crises require two main corrections.
– Improvement in primary public balances.
– Resumption of economic growth.
 Current estimates of required corrections to public
balances are large.
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Required fiscal adjustment between 2010 and 2020*
% of GDP
18
16
14
12
10
8
6
4
2
DEU
ITA
FIN
CAN
AUT
BEL
NLD
PRT
FRA
GBR
ESP
IRL
USA
JPN
GRC
0
* The adjustment needed to stabilize debt at the end-2012 level by 2030 if the respective
debt-to-GDP ratio is less than 60 percent or to bring the debt ratio to 60 percent in 2030.
Source: IMF.
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Effects of fiscal consolidations
 Usually reduced economic growth in the short run;
smaller costs e.g. when
– Consolidation is large and persistent
– Fiscal multipliers are small
 Usually positive long-run effects; better success if
– Main focus on expenditures, with no cuts on productive spending
– Initial conditions
• Large government
• Unsustainable debt-to-GDP ratio
 Possible Non-Keynesian effects
– Key mechanism: improved perceptions about future
– Lower probability of a ”mess” in an unsustainable situation
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Public debt dynamics after a financial crisis
 Consolidation takes several years.
– Examples: Finland 1991, Sweden 1991, Mexico 1994
 Not all countries reduced debt after a financial crises
– Examples: Korea 1997, Spain 1977
 Public debt crisis is necessarily a part of financial crisis.
– Example: Malesia 1997
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General government gross debt of Finland
1980–2009
70
% of GDP
60
50
40
30
20
10
0
1980
1985
1990
1995
2000
2005
Source: Statistics Finland.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
6
General government gross debt of Sweden
1980–2009
80
% of GDP
70
60
50
40
30
20
1980
1985
1990
1995
2000
2005
Source: European Commission.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
7
Total central government debt of Mexico 1980–2009
70
% of GDP
60
50
40
30
20
10
0
1980
1985
1990
1995
2000
2005
Source: OECD.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
8
General government gross financial liabilities of
Korea 1980–2008
30
% of GDP
25
20
15
10
5
0
1980
1985
1990
1995
2000
2005
Source: OECD.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
9
General government gross debt of Spain 1970–2009
80
% of GDP
70
60
50
40
30
20
10
0
1970
1975
1980
1985
1990
1995
2000
2005
Source: European Commission.
SUOMEN PANKKI | FINLANDS BANK | BANK OF FINLAND
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Challenges
 Carrying out a fiscal consolidation is inherently slow
and full of uncertainties that trouble the markets.
– Uncertainty about future fiscal and monetary policy.
– Uncertainty about future economic growth.
 Anchor expectations about future fiscal developments
– Clear multi-year program to improve credibility
– Substantial consolidation, possibly front-loaded
 Avoid disappointments during the consolidation
– set somewhat conservative goals
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 Develop better fiscal institutions
– Centralized key policy-making
– Multi-year expenditure ceilings
– This is the current challenge for EU and Euro area
 Structure of consolidation
– Focus on items with small or even negative fiscal multipliers
(briefly noted earlier)
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