German deficits: No more borrowing. That’s the new virtuous intention of the German government. But not before 2016, and only in “normal” times. The German plan is a reasonable start for a future that needs to come well before 2016. Otherwise, the world could face a series of debt crises in rich countries.
The German move is a salve to the conscience of Angela Merkel. The prime minister is rightly horrified by the size of the country’s deficit this year: 4 per cent of GDP. If other world leaders thought like Merkel, their consciences, too, might be troubled. The list of countries with deficits in double digit percentages of GDP include the US , UK , Spain and Ireland. Generations to come will pay the bill.
For many countries, the high current deficits only add to already huge debt mountains. Japanese and Italian debt already exceeds GDP. The eurozone’s “ Maastricht criteria”, which limited fiscal deficits to 3 per cent of GDP and targeted a government debt limit of 60 per cent of GDP, have begun to look quaint.
For now, markets are absorbing huge amounts of new government debt. But the limits are beginning to be tested.
Ireland has had to recognise that even though it entered the crisis with a modest debt to GDP ratio of 25per cent, it cannot run big deficits for long.Investors will fear default. It has therefore begun to cut back in the midst of recession and deflation.
The US has not yet begun to. But investors are showing their patience cannot be stretched much more. The government’s deficit may be pushing up debt yields. It has certainly undermined the dollar.
Governments need a new normality for fiscal policy. The Maastricht standard was not tough enough. Modest deficits in good times lead to huge deficits in recessions. The right goal is small fiscal surpluses when economic growth is decent. That will allow debt mountains to be eroded, and leave scope for deficits and stimulus when necessary. To get there, spending cuts and tax increases are the grim reality required as soon as the current crisis is over. Merkel is right: stimulus must yield to sense.
