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| Government Debt in G-7 Countries, 1950-2010 (in percent of GDP) Source: IMF
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Debt retrenchment in Europe will be “extremely painful” and take up to 20 years, the chief economist of the International Monetary Fund (IMF) warned on Tuesday.
"The adjustment is easier for countries that can devalue their currency. In countries that do not have this option, it is fair to say that the tightening will be extremely painful," Olivier Blanchard told Italy's La Repubblica newspaper.
He said the process would require concerted efforts "over 10 or 20 years."
In the short-term, he warned, countries would have low growth rates and "sacrifices on salaries will be inevitable in order to regain competitiveness."
Blanchard said that governments in Europe and the United States would have to impose spending cuts and tax increases in order to put public finances back in order in the wake of the economic crisis.
The chief economist has recently argued that Western economies should accept inflation rates of up to 4% from the common central bank standard of 2%. However, an article in the German magazine, Der Spiegel, says leading economists are unimpressed.
The article says that in 1972, Helmut Schmidt, then Germany's minister for both economics and finance, declared at an election campaign appearance that "5% inflation is easier to bear than 5%." When Schmidt became chancellor of West Germany just two years later, he got both. Inflation soared to 4.9%, while unemployment reached 7%, its highest level since the end of World War II.
Also on Tuesday officials from the European Commission, the European Central Bank and the IMF arrived in Athens at the start of a three-day trip to review Greece's efforts to cut its budget deficit from 12.7% of GDP (gross domestic product) to 8.75% in 2010.
The IMF said in Washington on Tuesday that the weakness of the global economy meant that emergency stimulus packages should be kept in place for many months. “In general, fiscal and monetary stimulus may need to be maintained well into 2010 for a majority of the world’s economies” until there was firm evidence of recovery, it said.
The Fund said that one of the key lessons of previous economic crises was that “premature withdrawal of policy stimulus can be very costly.” It added: “Thus, in the current context, the potential risks associated with an early withdrawal of policy stimulus seem to outweigh the risks of maintaining it for longer than possibly needed.”
The IMF said the most daunting task is to restore fiscal and debt sustainability and its executive board has generally agreed that a medium-term adjustment strategy aimed at ultimately reducing debt ratios to pre-crisis levels or below, depending on country circumstances, should be communicated early to reassure markets of policymakers’ commitment. It said unwinding discretionary support is only a first step. The bulk of the adjustment will require more difficult reforms, largely on the expenditure side, to improve the structural primary balance on a sustained basis.
The IMF directors see the crisis as an opportunity to advance needed reforms, including in the areas of age-related entitlements and privatization. They stressed that institutional reforms and reforms with long-term effects on spending and revenues can be undertaken now, insofar as they do not compromise the economic recovery in the short run, and should be complemented by reforms that aim to promote potential growth.
