World leaders leaving stimulus tactics aside amid fledgling recovery

By Neil Irwin
Washington Post Staff Writer
Thursday, June 10, 2010; A12

FRANKFURT, GERMANY -- Tough economic times are far from over, yet leaders around the world have started to move on.

After spending much of the last two years using nearly every tool at their disposal to fight the sharpest global downturn in decades, they have begun placing a high-stakes bet that the recovery is now strong enough to sustain itself and that it's time to pull back government support for growth. In recent days, this global pivot has gained pace as leaders seek to avoid the threat of a debt crisis or inflation.

If their timing is right, the leaders would be acting with foresight that is rare in financial history. If they are wrong and are pulling the plug on economic stimulus too soon, they are consigning tens of millions of people around the world to unemployment.

The specifics -- and extent -- of the pullback vary around the world. In Germany, Chancellor Angela Merkel this week proposed 80 billion euros in spending cuts and new fees meant to reduce the budget deficit. Top British officials began laying out plans for massive budget cuts of their own this week. Japan's new prime minister, Naoto Kan, said this week that one of his top priorities will be reducing a budget shortfall; he appointed a deficit hawk as finance minister.

Although Obama administration officials have been more reluctant than many counterparts overseas to begin the Great Pivot, the White House told federal agency heads on Tuesday to identify how they would cut 5 percent from their budgets. Centrist Democrats in Congress are even more eager to trim the government's sails, pushing late last month to scale back a jobs bill as part of fighting the deficit.

Yet even as the ardor for economic stimulus has cooled, the dangers of moving on were highlighted last week by a dismal government report showing that private-sector job creation in the United States had all but stopped.

"Today, almost every major country in the world is focusing on the need to cut their deficits," David Cameron, the British prime minister, said in a speech Monday. "Around the world, people and their governments are waking up to the dangers of not dealing with their debts."

This approach became, in effect, the official position of the world's top economic policymakers at a meeting of finance ministers of 20 major nations last weekend in South Korea. Recent problems in European financial markets, the officials said in a joint statement, "highlight the importance of sustainable public finances and the need for our countries to put in place credible, growth-friendly measures, to deliver fiscal sustainability."

That was a reversal from an agreement in November 2008, at the height of the financial crisis, when the same countries said they would "use fiscal measures to stimulate domestic demand to rapid effect."

Preventive medicine

Countries such as Spain and Portugal, which face the immediate threat of a fiscal upheaval, are cutting their budgets under pressure from financial markets, which are charging them steeply to continue borrowing money. But the push toward austerity in Britain, France, Germany -- and in some quarters of the United States -- is more a preemptive strike designed to keep national finances from deteriorating to alarming conditions.

Financial crises in the past often have been followed by national debt crises within a few years. That's because governments have become dangerously overextended trying to prop up their financial systems. Finance ministers around the globe are now trying to head off that ugly prospect.

"What we're seeing in southern Europe is a warning shot for everyone else," said Thomas Mayer, the chief economist at Deutsche Bank.

For the United States, the question of when to pull the reins on spending or raise taxes can seem less urgent. The European debt crisis has in one regard made it easier for the United States to put off dealing with its own red ink because the troubles overseas make U.S. markets more desirable for global investors, which helps keep U.S. interest rates down.

But investor sentiment can turn quickly. "We don't know when financial markets will turn around and bite us," said Carmen Reinhart, a University of Maryland economist and co-author of a history of financial crises. "That can happen anytime." For the United States, she said, "it is important to not jump the gun on our own austerity, but at the same time it's very important to begin to convince everyone that soaring debts and deficits will not be part of the foreseeable future."

The move to budget-cutting comes at a major cost, however. Across most of the developed world, unemployment rates are far higher than they would be if the economies were healthy. In much of the world, conditions in the labor market are improving at a glacial pace, if at all, as underscored by the report last week about weak private-sector job growth in the United States.

A fragile equation

Further cuts in government spending threaten to worsen the problem by reducing an important stimulant for growth, and could even derail the global recovery.

"There is this consistent fear of debt and deficits that are causing them to pursue this path of fiscal prudence, but there's no pressing economic need for it," said Tim Duy, an economist at the University of Oregon. He cited the relatively low interest rates that still prevail in the United States, Britain, Germany and other nations now weighing fiscal restraint. "There is an immense human cost to moving too soon, in terms of higher unemployment and lost output," he said.

The International Monetary Fund has taken to advocating "growth-friendly" fiscal measures, language that has been used by U.S. Treasury Secretary Timothy F. Geithner and that appeared in the finance ministers' statements over the weekend.

By "growth-friendly," officials mean policies that commit to budget restraint in the future while not hemming in economic activity in the near term. The idea is to give financial markets confidence that the public spigot will be turned off eventually, while keeping it open until the economy is stronger.

Germany has been more eager to pivot than many others. Its deficit is less than half that of the United States, relative to the size of the two economies, and investors continue to view Germany as an extraordinarily safe place to put money.

But the German government is moving urgently into the era of austerity. The measures proposed by Merkel this week would begin next year and eliminate up to 15,000 government jobs, cut unemployment benefits, and add new fees on air travel and nuclear power plants. On Wednesday, Merkel said that Germany was withdrawing its stimulus and aiming for sustainable growth, rather than growth at any cost.

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