The International Monetary Fund said Thursday that budget austerity programs, like those underway in Europe, would dampen economic growth more than usual in the short term. Tax hikes and spending cuts used to reduce budget deficits typically lower growth in the short term, but under current conditions are projected to have a more profound effect on growth in advanced countries, the IMF said in releasing a chapter of its biannual World Economic Report.
"Our analysis suggests that fiscal consolidation usually dampens economic activity in the short term," the Washington-based institution said in a statement. "Our findings suggest that in today's environment, fiscal consolidation is likely to have more negative short-term effects than usual." IMF economists reached that conclusion after studying the impact of fiscal consolidation during the past 30 years on output and employment.
But as countries struggle to recover from the worst global recession since World War II, the IMF noted that the usual tools were not readily available.
"In many economies, central banks can only provide a limited monetary stimulus because interest rates are already near zero," the IMF said. In addition, if many countries adjust simultaneously, the IMF said, "the output costs are likely to be greater - since not all countries can reduce the value of their currency and increase net exports at the same time." The IMF projected that after two years, a budget deficit cut of 1.0 percent of gross domestic product tends to lower output by about 0.5 percent and raise the unemployment rate by one-third percentage point.
For economies considered at high risk of sovereign default, short-term negative effects are likely to be smaller, it said. At a news conference on the chapter, IMF economist Jorg Decressin insisted that fiscal consolidation nevertheless eventually has a positive impact on growth. "It's very important, I think, for us to spread that message, that consolidation is necessary," he said.
"When you have large fiscal deficits, it's like a family that is constantly spending more than it earns, it cannot go on forever, right? And it has its costs."
"But we also have to be clear that there is short-term pain. That is why people are concerned at this stage. But if we have a good assessment of the long-term gains then we hope that this will help carry forward the debate in Europe."
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