- Blog Post
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I doubt the IMF really wants the world to emulate the euro area’s fiscal policies.
After all, interest rates are low globally right now, and negative in many large advanced economies. That makes sustained deficits much less costly (if you get paid to borrow, your “intrinsic” debt dynamics are much more favorable), that makes borrowing to finance public investments much more attractive (real interest rates are negative), and that makes fiscal policy almost essential to manage a downturn (see Olivier Blanchard).
But the IMF officially believes that the euro area has its fiscal policy more or less right in the medium term. The Euro area ran a fiscal deficit of 0.7 pp of GDP in 2018. The IMF thinks the “right” fiscal stance for the euro area is a deficit of 0.2 pp of GDP (see table 3 of this paper, and for context, go here).
That puts the euro area much closer to its optimal fiscal policy than any of the world’s other large economies.
China: should run a fiscal deficit of 1.5 percent of GDP, not a deficit of 4.8 percent (using the IMF’s definition of the general government deficit).
Japan: should aim for fiscal balance, not a deficit of around 3 percent of Japan’s GDP.
The United States: should aim for a fiscal deficit of 1.5 percent of GDP, not 5.4 percent of GDP (the United States uses a broad definition of the government balances that includes the deficits of state and local governments).
In each of these countries, the IMF is calling for a fiscal consolidation of more than three percentage points of GDP over time.
To be clear, the IMF argues that these numbers are not its recommended near-term fiscal stance. Rather they are targets for the medium to long-term.
But they still show something important. While the IMF has put emphasis on pushing some European “surplus” countries to reduce their fiscal surpluses, the IMF’s country teams (for the bulk of the world) still want substantially tighter fiscal policy. Even inside the euro area, the IMF officially wants more tightening in a zero rate world.
The external surveillance report was meant to highlight global adding up problems: not everyone can grow on the basis of exports for example. But I think the report now reveals a different kind of adding up problem. If the world ever were to adopt the IMF’s fiscal advice (a two pp of GDP global consolidation), the world would lack demand—e.g. the IMF’s fiscal advice for the world at a time of extremely low global interest rates is still basically to consolidate more. The world as a whole should go from a fiscal deficit of around 3 percent of GDP to a fiscal deficit of around 1 percent of GDP—in other words, it should emulate Europe.
That at least is the message I take from the IMF’s Table 3.
The easiest way to see this is to work through the IMF’s estimates for a country like Germany.
The IMF wants Germany to loosen fiscal policy by a percent and a half of German GDP. That would help bring Germany’s surplus down. And the IMF’s latest article IV analysis of Germany does a good job of identifying other policy changes that would help to bring Germany’s surplus down (basically, policies to support higher wages and raise household income as a share of GDP).
Personally I think Germany, as a supplier of one of the world’s few true reserve assets, should run a somewhat bigger fiscal deficit than the IMF advocates—but it is hard to be too annoyed at the IMF’s advice when the IMF is pushing Germany in the right direction.
But the impact of the recommended fiscal expansion on Germany’s external surplus is estimated to be modest, about a half point of GDP.
The bulk of the expected shift in Germany’s surplus that would come from adopting the IMF’s recommended fiscal stance comes from fiscal consolidation in Germany’s main export destinations as the IMF globally wants a fiscal consolidation of about two percentage points. The global fiscal consolidation provides 0.7 pp of GDP of the 1.2 pp of GDP expected contribution from fiscal policy to reducing Germany’s surplus (see table 2).
And the IMF isn’t just recommending fiscal expansion in some surplus countries and fiscal consolidation in some deficit countries (like the United States)—it is also advocating fiscal consolidation in surplus countries with strong “stock” positions (lots of external assets) like China and Japan. In these countries, the IMF’s fiscal advice would actually work against the goal of keeping trade imbalances down.
Think about China—the IMF wants three percentage points of fiscal consolidation in China, something that would be expected to raise China’s current account surplus by about a percentage point. On its own, that would push China out of its current “balanced” external position.* The only reason why this doesn't show up clearly in the IMF's fiscal analysis is that the IMF wants a big fiscal consolidation in China's trade partners too. If everyone followed the IMF's advice, fiscal tightening in the United States and Japan and much of the euro area would pull down China’s exports even as China’s own fiscal tightening reduced its imports, leaving China close to external balance.
This may seem like criticism of the IMF’s external sector report. But it actually isn’t—without the IMF’s external surveillance report, it would be hard to know precisely what kind of policies the IMF is advocating for in the world as a whole.
It really is a criticism of the fiscal advice that emerges out of the IMF’s country work, which—if adopted universally—would impart a fairly strong deflationary bias to the global economy. The IMF’s recommended fiscal expansion in Germany, the Netherlands, Sweden, and Korea remains far too modest to offset its recommended consolidation in the world’s largest economies.**
In a sense then, it is a good thing that the odds are the IMF’s advice won’t be followed any time soon.
Though, Japan is planning to take a small step toward fiscal balance with another increase in its consumption tax…and China remains strangely committed to keeping its headline central government fiscal deficit under 3 percent of GDP. The IMF’s advice isn’t entirely irrelevant either.
* China’s reported external surplus in 2018 was modest, under 0.5 pp of GDP (it rose substantially in the first quarter of 2019). The modest overall surplus though is a combination of a still large surplus in manufactures and large deficits in commodities—partially a natural result of China’s limited resources, but also partially a function of the demand created by a still very high level of investment—and a large deficit in tourism (tourism accounts for more or less all of the reported services deficit, and part of that tourism deficit is real and part is likely fake). Adjusting for the exaggerated tourism deficit brings China’s surplus back above 1 pp of GDP (especially within 2019, I think there are some very technical reasons why the fall in China’s surplus in 2018 was exaggerated a bit). So if China adopted the IMF’s fiscal advice and basically reversed its on-budget stimulus of 2015 and 2016, I think China’s true surplus would be back over two percent of GDP.
** There are basically three policies that in my view can substantially move the needle on a country’s external balance in the IMF’s model:
a) fiscal policy (a dollar of fiscal consolidation reduces the external deficit by 33 cents in the model)
b) foreign exchange intervention (if a country has a high level of capital controls, a dollar of intervention raises the surplus by 37 cents—the 0.75 coefficient is misleading because the highest observed current setting for controls is 0.5, and the impact is the interaction of the two)
c) public health spending.
The IMF’s model, incidentally, implies that there is no point in debating whether or not the Trump administration will intervene in the foreign exchange market, as intervention by countries with open financial accounts has no impact (I disagree with this result, I think Gagnon’s estimates are more realistic). Right now though there isn’t much intervention globally—the IMF totally ignored Singapore’s intervention in its assessment of Singapore’s economy, but Singapore isn’t big enough to move the needle globally. And the IMF isn’t recommending all that much more public health spending in China or Korea. I think the IMF should reevaluate this, but the “health spending gap” in China is only 0.6 pp of GDP (the optimal level of public health spending is 4 percent of GDP vs. 3.4 percent now) and the gap in Korea is only 1.2 percent of GDP (Table 4). So the policy variable that really impacts the external balance right now is fiscal—even if that has been downplayed a bit in the Fund’s recent communications. The IMF incidentally knows my views here: I was invited to comment on the Fund’s external surveillance last fall, and my comments will soon be published in the resulting conference volume.