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Tags: economy | global | deficit

This Week, Global Spotlight Shines on Deficit-Cutting Efforts

Sunday, 12 February 2012 03:09 PM EST

Greece is cutting its minimum wage by 22 percent to win bailout money and Italy is raising its pension age to 67 in a taste of the harsh spending cuts that lie ahead for many advanced countries with huge budget deficits.

Yet central bankers and economists in the United States and Japan are renewing their warnings that severe fiscal contraction at this stage of their tentative economic recoveries could prolong the pain and slow return to strong growth.

A study by Richard Koo at the Nomura Research Institute in Tokyo showed that when private sector balance sheets need shrinking, as is the case for the United States and Europe, deleveraging takes at least 10 years and fiscal stimulus is the only way to offset lost growth and prevent stagnation or worse.

"Although shunning fiscal profligacy is the right approach when the private sector is healthy and is maximizing profits, nothing is worse than fiscal consolidation when a sick private sector is minimizing debt," Koo said.

Balance-sheet recessions are relatively rare compared with normal cyclical downturns. It took Japan 15 years to pay down its private debt and restore growth, an effort backed by massive fiscal and monetary stimulus.

Bank of Japan Governor Masaaki Shirakawa last month said that he sees many similarities with Japan's balance-sheet recession and the deleveraging problems now facing the United States, the United Kingdom and the euro zone.

It is a sobering thought that strong economic recoveries in the West could be delayed into the 2020s.

Recent data point to the recovery gaining some momentum in the United States, putting it on track for GDP growth above a 2.0 percent annualized pace for the second quarter in a row. In Europe, the economy appears to be flatlining, an improvement from the contraction that was widely forecast for this quarter.

Not so in Greece, where GDP is forecast to shrink 4.0 to 5.0 percent this year. Unemployed youth throwing petrol bombs and doctors walking out of hospitals show the depth of anger in Athens over deep spending cuts the government is trying to enact to qualify for a second bailout.

Euro-zone ministers have ordered Greece to find an extra 325 million euros in budget cuts this week, and vote on the package in parliament, to qualify for a new 130 billion euro package from the International Monetary Fund and European Union.

EU officials also have said Greece's private sector creditors must agree on terms by Wednesday for a debt swap if Greece is to avert a messy default in early March.

The United States, in contrast, has some breathing room before its publicly held debt, currently running at 70 percent of GDP, hits the danger zone.

By contrast, when President Barack Obama unveils his 2013 budget proposal on Monday, he is expected to heed advice from Federal Reserve Chairman Ben Bernanke that the United States should secure economic recovery before enacting a longer-term plan of deep budget consolidation.

The White House is expected to focus on infrastructure investments and job creation programs, coupled with higher taxes on the wealthy, rather than spending cuts. But Obama's proposal is simply a statement of Democratic priorities in this election year and few elements will be adopted by a Congress in which opposition Republicans control one chamber.

The U.S. budget deficit already is heading in the right direction. Tax revenues in January were about 4.0 percent above the year-ago level, putting the deficit on track to shrink by $22 billion to $1.08 trillion this year. For 2013, Obama's budget will forecast a $901 billion gap based on his policy proposals.

Euro-zone countries though face little choice but fiscal retrenchment to save their monetary union.


Central banks will provide some insight this week into their thinking over how much further support their economies might need to solidify recovery. Neither the Bank of Japan meeting on Tuesday nor Sweden's Riksbank on Thursday is expected to alter course.

When the Fed releases the minutes on Wednesday of its Jan 25th meeting at which it made its landmark decision to overhaul its monetary framework, the range of debate on adopting an explicit inflation target will be on display.

"More relevant will be how in-depth the discussion of additional means to ease was and how broad the support," said Bank of America/Merrill Lynch in a client note. Stronger growth, seen in factory indexes and employment gains, have investors questioning whether the Fed will need to buy more assets to ease credit.

A report on Friday is expected to show a moderation in consumer price rises to a 2.9 percent year-over-year rate in January.

The Bank of England on Wednesday releases its inflation report after it expanded asset purchases by a further 50 billion pounds last week. Investors are looking for clues on whether this round of quantitative easing will be "the last waltz", as Barclays Capital put it.

Currency war rhetoric may heat up on Tuesday and Wednesday, when China's Vice President Xi Jinping visits the United States. His views on China's economic slowdown will be keenly watched because if growth falters badly, China is likely to put the brakes on its yuan appreciation, a move that would anger U.S. politicians.

Export-dependent China is heavily exposed to a downturn in the euro zone, making any progress in resolving Greece important.

© 2023 Thomson/Reuters. All rights reserved.

Sunday, 12 February 2012 03:09 PM
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