The wrong debate

- "While the European bank stress test is a pivotal moment, the issue of fiscal consolidation remains equally important—in fact it is fiscal concerns that brought us to the banks stress tests. Yet the austerity debate is mis-guided: the focus should be more on how to boost
sustainable growth, less on whether to prolong fiscal stimulus. The austerity debate is now not on whether fiscal tightening in advanced economies is necessary, but on when it should begin in earnest. Those who favor postponing adjustment argue that the recovery is still fragile, and premature fiscal tightening could trigger a double dip recession, particularly as there is little scope for a monetary policy reaction. On the other hand, delaying adjustment
where public debt dynamics seem unsustainable risks weakening market confidence, making funding costlier and harder, and undermines potential growth and living standards once debt
becomes too high (90% of GDP for advanced economies). So when is the right time to start tightening? US real GDP is now close to its pre-crisis peak, but unemployment is more than twice as high; European output is 4-4 ½% below peak, but the increase in unemployment has been overall less severe, albeit with wide crosscountry differences. Should we wait till both output and employment are back to pre-crisis levels? Just as credit growth in the run up to the crisis was excessive, so was GDP growth was unsustainably high; just as much of the financial wealth created was illusory, so a substantial share of “real” output growth was
unsustainable, at best borrowed from the future. What rates of growth and unemployment would have been “normal” without the credit bubble? How many of the jobs destroyed in the recession might be gone for good? These are the hard questions to answer, to lay the basis for the appropriate policy response. Meanwhile, fiscal consolidation plans have already been laid out in most countries, they are not dramatic, and there is no significant push to tighten them further. We should spend less time conjuring the confidencekilling ghost of a double-dip recession, more on debating what reforms countries need to ensure stronger sustainable growth— which will also serve to bolster market confidence."
Unicredit Market Sense 20100720

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