Fiscal policy exit strategies

The exit strategy for fiscal policies raises three questions:

1. Timing. One view that it is now time to commit to and initiate a reduction of the large budget deficits that prevail in most developed countries. Another view is that uncertainty about the recovery (time, shape, firmness) calls for flexibility and opportunism. The first view is risky as, if applied prematurely, it could capsize a fragile recovery, with dramatic economic and political consequences. The second view delays the formulation of a strategy apt at alleviating widespread fears that the budget is durably out of control. The first view cannot be relied upon and the second view needs to be completed with credible commitments.

2. Coordination. Ideally, the fiscal policy exit strategy ought to be coordinated with the monetary policy exit strategy, and with fiscal policy strategies in other countries, both in Europe and elsewhere. Such coordination has been elusive following the onset of the crisis and there is no reason to believe that it can be achieved to craft exit strategies.

3. Definition. The effort to roll back public debt is of historical proportions. All margins of action will be required: the effort will have to be spread over time and over all instruments and it will have to be underpinned by a credible long-run commitment. The Stability and Growth Pact is ill-adapted to this effort. A better framework is the adoption of balanced-budget rules, which are credible because of their legal status and which include adequate escape clauses. A good example is the amendment to the German constitution adopted in June 2009.