Cottarelli Discusses Fiscal Accounts

“How about debt restructuring or, in plain English, not paying your bondholders?” Cottarelli asked next. “This is not a cost-free option. After default, when a country goes back to the market, it will have to pay a higher risk premium. We should not forget that default is a tax on the bondholder and therefore has the same deflationary effects on the economy as any tax. I think that the cost of debt restructuring is quite high.”

Cottarelli then turned to two requirements for governments to navigate their fiscal adjustments succesfully. The first was structural reforms to raise potential growth.

“[Structural reforms] are important because it affects the debt-to-GDP ratio,” he said. “Also, it is easier to run large primary surpluses when an economy is growing a lot. If there is an increase of growth per year, it will lower the debt-to-GDP ratio.”

The second requirement was that countries implement a strategy to keep interest rates under control. Cottarelli described four aspects of this requirement. The first was a “medium term fiscal adjustment plan.” The second was determining the appropriate pace of fiscal adjustment, which depended on the market circumstances facing each country, as well as the amount of fiscal adjustment necessary.

The third was defining the appropriate balance between increased taxation and decreased spending for each country. He noted that it would be better in the long term for European countries to cut spending, while the U.S. and Japan had room for raising taxes. The fourth aspect of the strategy was relaxed monetary policy.

“In several advanced economies, the fiscal accounts are in really bad shapes,” Cottarelli concluded. “It will take decades to lower [them] to sustainable levels. It is not impossible, but there are not good shortcuts.”