[Note: A transcript of this meeting is unavailable. The discussion is summarized below.]
What We Know
The U.S. Administration's recent fiscal proposals, intended to stimulate growth, will lead to a drastic weakening in the long-run budget position over the next ten years. In Europe, by contrast, the EU's Stability and Growth Pact is demanding fiscal retrenchment for France and Germany at a time of economic stagnation. Both U.S. and EU policies have attracted much criticism, and their economic implications will be felt globally.
What We Don't Know
- There was debate over the likely impact in the long-term of the Administration's fiscal policy. Both the Congressional Budget Office and Administration's budget projections were felt to be excessively optimistic; the projected deficit will be pushed up by technical factors and the likely extension of several tax provisions beyond their sunset clauses. The level of productivity growth over the next ten years is also hard to predict, and will have an impact.
- There is also considerable uncertainty about this year's U.S. deficit figures. The projections do not include the cost of the Iraq war and reconstruction – and as yet we know very little about the latter. And, alarmingly, budget revenues so far this fiscal year are sharply down from expectations, with a strong likelihood of a revenue shortfall from projection of at least $97 billion for this year.
- What are the long-term economic consequences of the growing U.S. fiscal deficit? Most agreed that a crisis, where a sudden inability to finance the deficit leads to a sharp rise in interest rates and decline in the dollar, is not likely. A painful, but gradual, process of adjustment and fiscal contraction in later years was foreseen by many in order for the government to service the mounting debt burden implied by the near-term deficits.
- There was debate over why the huge shift into deficit has not aroused greater opposition. Some people felt that political opposition would only come when there was more general dissatisfaction with economic performance that a political leader could use to rally support for fiscal discipline. A number noted that the big changes in both economic and budget performance since the 1980s had changed the debate about deficits, and with interest rates so low it was hard to make the argument that government borrowing was crowding out the private sector.
- But several participants expected a revival of concern over deficits. This was particularly so since the fiscal outlook is worse now than it was in the 1980s, with the long-run prospect of baby-boom retirement so much closer, and fewer opportunities for savings in the budget. A number felt that the fiscal position was one factor contributing to the weaker dollar, and that the trend on the dollar had turned.
- On Europe, most participants felt that stimulative deficits are exactly what Europe needs at the moment, all the more so because of its greater reliance on fiscal policy as a tool of stabilization. There was discussion of likely policy developments in both Germany and France. The Stability and Growth Pact calls for both to follow contractionary fiscal policies in the face of stagnant economic conditions; on the other hand, they may choose to ignore the deficit cap.
- Others offered a defense of the EU's goal of fiscal restraint. Although Europe is in need of short-term stimulus, EU fiscal constraints recognize long-run problems for the budget, given demographic trends and entitlement programs. Europe may be seen as sacrificing short-term growth to get the fiscal house in order, in preparation for demographic problems far graver than those faced in the United States. However, the justification for restraint that is typically put forward by Europeans at the ECB and the EU commission, the need to maintain "credibility" of the Pact underlying EMU, was widely viewed as unconvincing.
- Is there a conflict between policies that the United States and Europe should enact for their own interests, and policies that would be good for the rest of the world? Clearly the negative long-run implications of U.S. fiscal policy will not be confined to the United States. Lower U.S. net savings would tend to raise world interest rates. A declining dollar will impact on European growth. Conversely, Europe's fiscal retrenchment is keeping the world at a lower level of output, and is therefore also damaging.
What Are the Next Steps?
By disciplining itself ahead of global ageing Europe is sacrificing short-term stimulus for long-term sustainability. In contrast, the United States could be getting itself into a very unpleasant situation in the long-run. Policy changes are needed in both continents:
- U.S. fiscal policy should be aimed at short-term demand stimulus without the damaging long-run effects of current policy. The dividend tax cut being proposed is inappropriate; we need fiscal policy with more immediate effects and without the long-term deficit impact.
- Europe should revise the Stability and Growth Pact to focus more on structural than actual deficits, and more on the debt than just the deficit target. This would give Germany and France more flexibility to enact much-needed stimulative fiscal policies.