Alternative Fiscal Medicine?

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Forget the fiscal cliff. The real issue is the fiscal mountain. According to the InternationalMonetary Fund, the challenge of reducing the public debt/GDP ratio to a safelevel is daunting for most advanced countries.
In Europe, many governments, havingembarked on the path of fiscal consolidation while their economies werestill weak, are now struggling with the growth consequences. As a result, debtstabilization seems to be an increasingly elusivetarget.
In the US, consolidation has barely begun. Because theprivate economy is now stronger, it may benefit from more auspicious growth conditions, but the magnitude of thefiscal retrenchment needed – more than tenpercentage points of GDP, according to the IMF – is frightening. In Japan,nothing has been done thus far and the size of the required effort defiesimagination.
All advanced-country governments are still officiallycommitted to undergoing the pain of adjustment. But how many will becomeexhausted before implementing this program in full? Willinglyor not, some may seek recourse to inflation or administrative measures aimed at trappingdomestic savings into financing the state and keeping bond rates low (whateconomists call financial repression) – or, eventually, to outright debt restructuring.
All three unorthodox remedies have been used in past debtcrises. They can be regarded as alternative forms of taxation,albeit implicit rather than explicit. In the end, they are different methods offorcing current and future generations toshoulder the burden of accumulated debt.
Is it preferable to adjust in full?Or is it advisable to blend consolidation with a dose of alternative medicine?
Here, the discussion is often couchedin moral terms. Adjustment, we are told, is morally commendable,whereas the alternatives all amount to repudiatingthe contracts that governments entered into with bondholders.
This may be true, but governments are political animals.They care more about voters’ welfare than about moral principles. So it is worth discussing in purely economic terms whatorthodox and unorthodox choices imply from the standpoints of equity andefficiency.
Start with equity. From this perspective, adjustment ishard to beat. Combining taxation and spending cuts allows the burden ofadjustment to be distributed precisely. The decision belongs to the legislator.Some adjustments, like in France nowadays, weigh mostlyon high-income, high-wealth individuals; others, like in Italy, weigh onpensioners. These choices were madedemocratically, in parliaments, as part of budget decisions.
The unorthodox techniques, however, are less nimble and more opaque.Inflation affects those with assets (cash, bonds) orincomes (wages, income from saving accounts) that are not indexed (orare under-indexed) to prices. Financial repression isbasically a form of administrative taxation of domestic savings. Andrestructuring is a levy on bondholders’ wealth, including that of middle-classpension savers. On distributional grounds, there does not seem to be a goodreason to resort to them
in lieu ofrelying on outright taxation.
There are exceptions, though. First, governments andparliaments may be politically unable to take responsibility for distributionalchoices and prefer to keep them hidden. This is not a good reason, but it doeshappen.
Second, restructuring concentrates the burden on thoseholding bonds issued before a certain cut-offdate. It thus draws a line between the past and the future – leading to what JohnMaynard Keynes called “euthanasia of the rentier.” When the burden of past turpitude is too heavy, there may be no other way toprotect future generations.
Finally, both inflation and restructuring put some of theburden on non-resident bondholders (through exchange-rate depreciation and thedirect reduction of the value of assets, respectively). For taxpayers, this isa tempting formula, especially when a large share of the debt is heldexternally. To make foreigners pay is, however, disputable. After all, theywere not the beneficiaries of the public goodsor transfers financed by the issuance of debt.So it should be reserved for cases when the country as a whole has grown insolvent.
Turn now to efficiency. Large-scale adjustments may leave an economy with a weaker capacity to generategrowth, because high taxes have deterred investment or cuts in public spendinghave eroded the quality of infrastructure and education. But this is true ofthe unorthodox remedies as well.
Financial repression distorts choices by channeling savings to budget financing and awayfrom investment. Inflation implies higher long-term interest rates untilmarkets regain confidence in the central bank. And restructuring weakens banks,which generally hold large portfolios of government bonds, thus making themless able to finance the economy. Indeed, restructuring undermines thefoundation of the entire financial system: the safe-asset role of sovereigndebt. As developing countries have learned from experience, all these effectsare bad for capital allocation and growth.
But an exception can again be made: When both the privateand public sectors are overburdened with debt, adjustment leads to adebt-deflation spiral, particularly when conducted under a fixed exchange-rateregime. In such conditions, full adjustment risks becoming self-defeating, or at least unreasonably painful, asillustrated by the Greek case. Despite their economic costs, restructuringpublic debt or eroding all public and private liabilities through inflation canbe less detrimental options.
In the end, the alternatives to adjustment are not soft. Barring extreme situations, they generallyunderperform fiscal adjustment from the standpoint of equity, and are no betterin terms of efficiency. So the idea that they offer an easy way out of advancedcountries’ current predicament is a fantasy.
Rather than flirting with illusions, governments shouldconfront the hard choices ahead of them. Relying on alternative remedies issometimes necessary, but they are not painless. They should be consideredtreatments of last resort.

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关键词：Alternative Medicine alterna Fiscal native challenge countries mountain public growth

All advanced-country governments are still officiallycommitted to undergoing the pain of adjustment.Willinglyor not, some may seek recourse to inflation or administrative measures(fanacial repression) aimed at trappingdomestic savings into financing the state and keeping bond rates low (whateconomists call financial repression) – or, eventually, to outright debt restructuring.All three unorthodox remedies have been used in past debtcrises. They can be regarded as alternative forms of taxation,albeit implicit rather than explicit. In the end, they are different methods offorcing current and future generations toshoulder the burden of accumulated debt.

it is worth discussing in purely economic termswhat orthodox(adjustment(tax ,spending cut)) and unorthodox choices(inflation or administrative measures(financial represssion),debt restructuring) imply from the standpoints of equity andefficiency.



Start with equity. From this perspective, adjustment(orthodox way)is hard to beat. Combining taxation and spending cuts allows the burden ofadjustment to be distributed precisely. The decision belongs to the legislator.These choices were made democratically, in parliaments, aspart of budget decisions.
The unorthodox techniques, however, are less nimble and more opaque.Inflation affects those with assets (cash, bonds) orincomes (wages, income from saving accounts) that are not indexed (orare under-indexed) to prices. Financial repression isbasically a form of administrative taxation of domestic savings. Andrestructuring is a levy on bondholders’ wealth, including that of middle-classpension savers. On distributional grounds, there does not seem to be a goodreason to resort to themin lieu of relying on outright taxation.
There are exceptions, though. First, governments andparliaments may be politically unable to take responsibility for distributionalchoices and prefer to keep them hidden.Second, restructuring concentrates the burden on thoseholding bonds issued before a certain cut-offdate.When the burden of past turpitudeis too heavy, there may be no other way to protect future generations.Finally, both inflation and restructuring put some ofthe burden on non-resident bondholders (through exchange-rate depreciation andthe direct reduction of the value of assets, respectively). For taxpayers, thisis a tempting formula, especially when a large share of the debt is heldexternally. To make foreigners pay is, however, disputable. After all, theywere not the beneficiaries of the public goodsor transfers financed by the issuance of debt.



Turn now to efficiency. Large-scale adjustments may leave an economy with a weaker capacity to generategrowth, because high taxes have deterred investment or cuts in public spendinghave eroded the quality of infrastructure and education.

But this is true ofthe unorthodox remedies as well.Financial repression distorts choices bychanneling savings to budget financing and away from investment. Inflationimplies higher long-term interest rates until markets regain confidence in thecentral bank. And restructuring weakens banks, which generally hold largeportfolios of government bonds, thus making them less able to finance theeconomy. Indeed, restructuring undermines the foundation of theentire financial system: the safe-asset role of sovereign debt.
But an exception can again be made: When both theprivate and public sectors are overburdened with debt, adjustment leads to adebt-deflation spiral, particularly when conducted under a fixed exchange-rateregime. In such conditions, full adjustment risks becoming self-defeating, or at least unreasonably painful, asillustrated by the Greek case.Despite their economic costs, restructuring publicdebt or eroding all public and private liabilities through inflation can beless detrimental options.





In the end, the alternatives to adjustment are not soft. Barring extreme situations, they generallyunderperform fiscal adjustment from the standpoint of equity, and are no betterin terms of efficiency. So the idea that they offer an easy way out of advancedcountries’ current predicament is a fantasy.Relying on alternative remedies is sometimes necessary, butthey are not painless. They should be considered treatments of last resort.