The Lingering Effects of the Great Financial Crisis

The global financial crisis (GFC) that precipitated the worldwide great recession in 2008 has largely subsided. Capital markets are generally operating smoothly, liquidity restored and brand new initiatives toward financial legislation aim at reducing the likelihood of repeat. However, in other values the effects of the crisis survive.

Many leading economies are can not regain adequate levels of financial growth, even with historically reduced (in cases even negative) federal government interest rates. Moreover, large government budget deficits during the economic downturn, attributable to the economic weakness itself as well as expansionary fiscal measures targeted at combating it, have left many advanced economies with bigger levels of national debt than they had just a few years earlier.

In confronting many remaining and heavy economic challenges, advanced financial systems face greater fiscal stress. This pressure comes not just from elevated debt-to-GDP ratios, which have received considerable attention, but also substantial and largely not related fiscal challenges over the long term. These are attributable to demographic alter, the rising cost of age-related social insurance and other spending programs. While focusing on managing the short-term debt load may help avoid crises like the one playing out in Greece, interest and policy actions must eventually turn to the longer-term fiscal problem.

Estimates of current-policy fiscal trajectories one of the world’s advanced economies may evaluate their long-term fiscal durability. Studying these economies, it is extremely evident that though the short-term financial measures used in many nations, such as the debt-to-GDP ratio and the current budget deficit as a share of GDP, may in some cases be reasonably good indicators of long-run sustainability.  Australia as well as South Korea, for example, bear small relationship to the sustainability associated with policy for many others.

This is true with regard to Italy and Greece, that appear to be on relatively environmentally friendly paths despite challenging short-run figures, and for Japan and the United States, for which worrisome short-run measures nevertheless understate the magnitude of long-run challenges.  Whilst one may have the ability to discount our negative long-term forecasts due to the uncertainty involved in such forecasts, based on the demographic changeover that is underway, one cannot ignore their general unfavorable direction.

Many advanced countries face fiscal challenges that — instead of primarily evolving from prior debt obligations — concern future obligations, with an increasing effect on primary deficits. These obligations are primarily associated with the cost of providing pensions and health care in the face of growing old-age dependency percentages. These ‘demographic and health’ deficits present a number of challenges to the formulation and implementation associated with future fiscal adjustments.

Standard budget control rules and other related systems do not integrate longer-term adjustments in such ‘implicit’ liabilities and so exert less pressure for undertaking these adjustments. There is also enormous uncertainty about the magnitude of these implicit liabilities, which makes the politics of adjustment more difficult, despite the fact that increased uncertainty about long term costs should, in theory, lead to even more budget stringency to prevent outcomes, which are socially very expensive.

There is also no simple formula for adjustment. Countries vary with respect to the severity of their instability, the composition of their instability and their fiscal capacity to absorb additional tax increases instead of relying on reductions in investing. The recent literature on fiscal consolidation has focused particularly on tax increases as opposed to expenditure reductions, but coping with longer-term fiscal gaps requires a various focus.

For example, given their importance as a source of financial gaps, reform of pension and healthcare systems is clearly a central agenda item for many advanced nations.

Some countries, such as Italy, have already introduced pension reforms recently and face much lower fiscal gaps as a result — if these types of pension reforms sustain. Health care reform is a more complex issue. It does not simply deal with a system of taxes and transfers but also with the structure of a very large and complex series of markets and the incentives associated with their operations.

This means that even with costs reforms, rising expenditures as a share of GDP might be inevitable making tax raises a necessary condition for fiscal balance. However, with a longer planning horizon tax increases can take a variety of forms, such as opening the possibility of more architectural reforms, which are more efficient than increasing marginal tax prices.

Finally, fiscal gaps that are attributable to large implicit liabilities are not easy to deal with through conventional budget control mechanisms that focus on explicit debt and short-term loss. Indeed, policies to deal instantly with long-term fiscal gaps might over the short-term result in large, though temporary, budget surpluses (in order to accommodate longer-term spending growth). The ability of the actual political process to sustain this kind of surpluses is certainly questionable.

These challenges require new approaches to budget manage. One such measure would be to expose or strengthen the role associated with independent fiscal councils or budget authorities. These establishments could improve transparency, reveal gaps in logic and supply support for needed alterations in fiscal policy that may need implementation over a number of years.

The excellent recession left nearly all advanced economies with substantially greater debt-to-GDP ratios and in many cases with lingering economic weakness that additional complicates short-term efforts at fiscal consolidation. But the longer-term challenges these countries face are in many cases related much more to the long term fiscal challenge of growing main deficits, associated with the cost of providing pensions and health care in the face of growing old-age dependency ratios, and not reducing overall debt.

Facing as much as the long-term fiscal challenges is republished with permission from East Asia Forum