At the Toronto summit in June 2010, leaders of the Group of 20 leading nations thought they had settled the vexed issue of the degree and pace of budgetary consolidation after the economic crisis.
Everyone signed up to the proposal that advanced economies (except Japan) would halve their budget deficits by 2013.
The pledge was designed to inspire confidence that governments had a grip on public finances and would lower borrowing as recovery continued. It was the moment the advanced world moved from stimulus to austerity and the proposals had widespread support.
A year later, fiscal policy is again in flux. The US scraped a political deal to increase its debt ceiling before the world’s largest economy descended into likely default in August. Standard & Poor’s, the credit rating agency, alarmed by the political damage caused by the debt ceiling fight, downgraded the US triple-A rating, sending markets into a tailspin.
Internationally, the disputes over fiscal policy, which characterised the supposedly harmonised response to the 2008-09 financial and economic crisis, restarted as the global recovery stalled.
Germany is under pressure to loosen its fiscal ties against its will. Christine Lagarde, the new managing director of the International Monetary Fund, has urged countries with the means to slow their austerity drives. The Organisation for Economic Co-operation and Development trod the same path in its September recommendations.
But Germany is putting strong pressure on the rest of the eurozone to cut deficits quickly, as storm clouds gather over Italy, Spain and Greece. It is dismayed that Barack Obama, US president, announced a jobs plan, cutting taxes and increasing spending at a rate that would make US compliance with the Toronto agreement difficult.
What once appeared a straightforward process of delivering what many thought was a reasonable budget deficit reduction plan amid a gradual recovery has suddenly become fraught with rancour and risk.
By the time the Group of Seven finance ministers and central bank governors met in Marseilles this month, there was ill-disguised frustration with the fiscal plans of other countries.
But the truth behind all these disputes is much more complex than the headline tensions suggest. Hidden behind claim and counter-claim are surprising starting points from which each country was adjusting policy this autumn.
Contrary to received wisdom, the US did not have the loosest fiscal plans of advanced economies. In fact, with tax cuts due to expire at the end of 2011, before the president’s speech, the administration was planning the deepest austerity drive in 2012 of any G7 country. It was seeking to close its underlying deficit by 1.4 percentage points of national income in 2012.
If Mr Obama can get his proposals through Congress – a big if – the US would only slightly relax its budget deficit by 0.4 percentage points of national income in 2012, according to Goldman Sachs, a move that hardly counts as a large fiscal stimulus.
In contrast, while Germany preaches austerity to the rest of Europe, it has the loosest plans for fiscal consolidation in the G7 for 2012. According to the IMF, its underlying deficit was set to fall only 0.6 percentage points, albeit from a low level to one even smaller.
The challenge now is to set fiscal policy at a time of deep uncertainty over two vital variables.
First, it remains unclear whether private-sector demand is so weak that government is the only economic actor willing to spend.
Second, people can only guess the effects of fiscal consolidation at a time when every leading economy is trying to get borrowing down simultaneously.
Global fiscal policy remains unresolved and the G7 was reduced to empty statements in Marseilles. When ministers call for “growth-friendly fiscal consolidation”, as they did in Marseilles, their objective is evident, but their policies and likely reaction to shocks are undefined.
With the big issues in flux, countries are enshrining their existing deficit reduction programmes in legislation in an attempt to convince markets that their resolve is strong.
If the world economy continues to slide, fiscal policy will not be set by legislation but by the altogether more unpredictable whims of the wider global recovery.
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