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Defying fiscal deficits

8 November 2010

Government budgets are under pressure as the recession and economic crisis continue to take a toll. The crisis has pushed public deficits and debt to unsustainable levels for many countries, OECD experts say, as weak economic activity causes tax revenues to dwindle, forcing crisis-embattled governments to borrow in a cautious market to pay for services and welfare, and in some cases, still limping banking sectors.

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Smaller OECD economies have been under the spotlight. Ireland’s fiscal deterioration was the most marked in the OECD area, by the equivalent of about 17% of GDP in 2009 compared with 2006 when general government finances showed a surplus of 3% of GDP. Moreover, market borrowing costs have remained high, despite rapid policy responses that, in the view of the Wall Street Journal recently, have done “everything the market could have expected to shore up both its banks and its own finances”.  At the time of writing, investors were charging some 500 basis points more to hold Irish 10-year bonds than for equivalent German bonds; in 2008 the gap was far narrower, when Irish long-term interest rates averaged 4.6%, compared with 4% in Germany.

Not all OECD countries have recorded as sharp a deterioration in their finances, with Austria and Germany in particular containing the slide to less than 2% of GDP.

Some larger economies also face tough budget decisions. The US government budget deficit and debt are higher than before the recession, with the deficit widening by over 8% of GDP in 2006-2009. According to the OECD’s latest US Economic Survey, while the government’s goal of reducing the federal budget deficit to 3% of GDP by 2015 is laudable, the speed of reduction could depend on economic developments.

Reducing these deficits is not easy, and a period of unprecedented budgetary consolidation, of some 6 to 9% of GDP, or possibly more to get public debt down, lies in store for many countries, the OECD warns.

Ultimately economies need to grow, though not any growth will do: as the OECD Strategic Response to the Crisis states:

Once the recession is over, the global economy should not go back to business as usual, as past practices have proven to be unsustainable.

Financial times are tough, but from the US through Ireland to Japan, the quality of reforms will be crucial for rebuilding confidence, stability and a stronger, cleaner, fairer world.

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