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IMF Cannot Quit Fiscal Consolidation (in Asian Surplus Countries)

by Brad Setser
August 22, 2016


In theory, the IMF now wants current account surplus countries to rely more heavily on fiscal stimulus and less on monetary stimulus.

This shift makes sense in a world marked by low interest rates, the risk that surplus countries will export liquidity traps to deficit economies, and concerns about contagious secular stagnation. Fiscal expansion tends to lower the surplus of surplus countries and regions, while monetary expansion tends to increase external surpluses.

And large external surpluses should be a concern in a world where imbalances in goods trade are once again quite large—though the goods surpluses now being chalked up in many Asian countries are partially offset by hard-to-track deficits in “intangibles” (to use an old term), notably China’s ongoing deficit in investment income and its ever-rising and ever-harder-to-track deficit in tourism.

In practice, though, the Fund seems to be having trouble actually advocating fiscal expansion in any major economy with a current account surplus.

Best I can tell, the Fund is encouraging fiscal consolidation in China, Japan, and the eurozone. These economies have a combined GDP of close to $30 trillion. The Fund, by contrast, is, perhaps, willing to encourage a tiny bit of fiscal expansion in Sweden (though that isn’t obvious from the 2015 staff report) and in Korea—countries with a combined GDP of $2 trillion.*

I previously have noted that the Fund is advocating a 2017 fiscal consolidation for the eurozone, as the consolidation the Fund advocates in France, Italy, and Spain would overwhelm the modest fiscal expansion the Fund proposed in the Netherlands (The IMF is recommending that Germany stay on the fiscal sidelines in 2017).

The same seems to be true in East Asia’s main surplus economies.

Take the Fund’s advice on China. The Fund thinks that the right measure of China’s fiscal position is what the Fund calls the “augmented fiscal balance.” And the Fund thinks that the augmented deficit is too big, and China should do modest consolidation in 2017.**

“The projected increase in the augmented deficit in 2016 is thus not warranted from a structural perspective. Neither is it warranted from a cyclical perspective given the growth outlook. For 2017, a moderate reduction of the augmented deficit seems appropriate. Only if growth threatens to fall sharply (well below staff’s projection of 6.2 percent) should the deficit widen.”

(emphasis added; paragraph 36, on p. 23 of the staff report)

To be fair, the Fund isn’t calling for on-balance sheet fiscal consolidation, and even seems open to breaching the 3 percent of GDP limit for the headline deficit if that is needed to support more aggressive reforms. Directionally, though, the Fund still wants consolidation.

Take the Fund’s advice on Japan. The first consumption take hike—from 5 to 8 percent—didn’t go that well. Consumption never recovered, and the economy lost momentum.

But rather than reconsider consumption tax based consolidation, the Fund wants Japan to double down and commit to raise the consumption tax to 15 percent (rather than 10 percent):

“a gradual increase in the consumption tax towards at least 15 percent, e.g., in increments of 0.5–1 percentage points over regular intervals, would better balance the objectives of supporting growth and achieving fiscal sustainability in the long run. … Starting the increases as soon as possible and replacing the currently planned 2019 hike with such a pre-announced, gradual path would enhance the credibility of the long-run fiscal adjustment effort…”

(paragraph 23, on p. 14 of the staff report)

That isn’t exactly a call to use the fiscal arrow to relaunch Japanese demand growth. The Fund is calling for slower and more predictable pace of consolidation, but it is still calling for consolidation, and a form of consolidation that would weigh most heavily on households. Monetary and fiscal policies would work in opposite directions.

Japan is a hard case. It has an unusually high level of public debt. It also has an unusually low interest rate on that debt. And fiscal risks are reduced so long as the stock of debt actually held by the public is falling fast: Think of a 5 percent of GDP fiscal deficit and annual purchases by the Bank of Japan (BoJ) of 15 percent of GDP (Or take a look at Figure 3 in Toby Nangle’s paper). With fiscal consolidation at a steady 0.5 percent of GDP pace needed for the next ten to fifteen-plus years according to the Fund (see paragraph 23 of the staff report) it is a little hard to see how the BoJ can stop buying any time soon—so if Japan adopted the Fund’s advice, the fall in debt held in the market would likely be quite fast.***

And what of Korea? The details of the Fund’s advice for Korea are still not out. But there is no real evidence the Fund wants a significant, sustained fiscal loosening in Korea, even though Korea has low government debt, no fiscal deficit to speak of and a $100 billion-plus current account surplus (7-8 percent of Korea’s GDP). The Fund’s forecast, if I read it correctly, projects that Korea’s general government will return to a fiscal surplus of 1.0 percent of GDP over time.**** Korea needs to ease just to avoid tightening, so to speak.

Asia’s two big surplus countries (China and Japan) no doubt present a slightly more complicated case than the eurozone taken as a whole. The eurozone is in primary balance, and in aggregate, has only a modest deficit. The absolute size of China’s augmented deficit and Japan’s primary deficit no doubt bother many at the Fund. On the other hand both China and Japan run significant external surpluses even with sizable fiscal deficits; the obvious implication is that without those fiscal deficits the size of their external surpluses would be much bigger. Korea has no fiscal deficit to speak of, and a current account surpluses that is bigger, relative to its GDP, than the current account of either China or Japan.

Bottom line: if the Fund wants fiscal expansion in surplus countries to drive external rebalancing and reduce current account surpluses, it actually has to be willing to encourage major countries with large external surpluses to do fiscal expansion. Finding limited fiscal space in Sweden and perhaps Korea won’t do the trick. 20 or 30 basis points of fiscal expansion in small economies won’t move the global needle. Not if China, Japan, and the eurozone all lack fiscal space and all need to consolidate over time.

[*] See table 3 of this report for the Fund’s assessment of the gap between a country’s 2015 fiscal balance and its appropriate long-term balance. Sweden should go from a surplus of 0.3 percent of GDP to balance, and Korea from a surplus of 0.6 percent of GDP to rough balance (a deficit of 0.1 percent of GDP)
[**] The IMF is not calling, thankfully, for China to reduce its on-budget fiscal deficit, which is forecast to remain at close to 3 percent of GDP for some time. But the Fund is clearly calling for a significant overall consolidation, along with slower growth in private credit.
[***] I assume the Fund expects that Japan’s supplementary budget will offset the 0.8 percent of GDP fiscal consolidation that the Fund projects for calendar 2017 in Japan. The staff report didn’t seem to warn of the demand side impact of allowing past stimulus packages to roll-off without being replaced with new stimulus. The tendency toward consolidation from the roll-off of past stimulus packages makes it hard to assess the actual fiscal impetus in Japan, as Japan is on a bit of a treadmill where ongoing temporary stimulus has to be replaced by new stimulus just to avoid a negative fiscal impulse.
[****] Korea’s national pension system collects significantly more than it takes in, generating a substantial surplus. The headline fiscal deficit of the government thus differs from the general government’s fiscal balance.

Note: I initially wrote that the IMF forecasts Korea’s general government balance to rise to a surplus of 1.5%. It looks to be 1% (using general government net borrowing/ lending). I also corrected a couple of spelling errors.


  • Posted by David Olsen

    On the surface the neo-liberal tide goes out, below the surface the same currents remain.

    You really do great articles, easy for a layman like myself to read, insightful.

  • Posted by jacopo

    the imf, in my reading advocates for short term demand support and wage hikes for Japan.

  • Posted by jacopo

    see para 21

  • Posted by jacopo

    so factually it is not the case; the blog mixes up long, medium term with short term

  • Posted by Brad Setser

    Jacopo, doesn’t paragraph 21 need to be read in conjunction with paragraph 23 (which wants a half point to a point rise in the consumption tax starting as soon as possible), and seems to support a 0.5% of GDP annual consolidation? “A steady fiscal consolidation by 0.5 percent of GDP per year through 2030 would be sufficient to put the public debt-to-GDP ratio on a downward path. In addition to the consumption tax increase, broadening the tax base, containing nominal social security spending growth to 0.5 percent and implementing some other expenditure reforms would balance the adjustment between revenue and expenditure side”

    And in conjunction with paragraph 27, which reads: “Policy space will be very limited and should be used sparingly. Without ambitious income policies and the associated comprehensive reforms, an expansionary fiscal policy stance could be counterproductive by raising risk premiums. Nonetheless, the weak outlook suggests that the fiscal stance will need to be broadly neutral in the near term.”

    I interpreted near term to be 2016, with the IMF advising consolidation to start in 17 (per paragraph 23). I guess it could be interpreted as starting in 2018, though the IMF was not at all clear on that point (unless i missed something) given the emphasis on starting the pre-announced consumption tax hikes as soon as possible. given the broader public discussion, i thought the fund leaned rather strongly against using fiscal policy to support demand in a sustained way (it leaned in favor of incomes policy instead). let me know if you disagree

  • Posted by Brad Setser

    and a bit more from the fund; this time in their press release:

    “Japan has limited room for monetary and fiscal stimulus given the high gross and net public debt, a budget deficit at about 5 percent of GDP in 2016, the Bank of Japan’s balance sheet—one of the largest among advanced economies—and policy interest rates dipping into negative territory.”


    “Renewed focus on fiscal policy: Japan’s key long-term challenge remains—achieving fiscal sustainability. Here, the report recommends that the authorities adopt a gradual but steady path of consumption tax increases, starting as soon as possible, and an explicit expenditure rule to contain social security spending growth.”

    i would emphasize the “starting as soon as possible” bit on the consumption tax. I do not think reading that as 2017 is wrong.

  • Posted by Brad Setser


    look at this:

    “Under our proposed policy package, the government would commit to a gradual increase of 0.5 percentage points in the VAT rate each year starting with the fiscal year 2017/18 in order to get the VAT rate to 15 percent by fiscal year 2029/30. Such policies would ensure a gradual decline in the debt-to-GDP ratio over the long term. However, if the authorities decide to pursue their current strategy, it will be important to plan for a fiscal stimulus offset to reduce the negative impact of the VAT increase”

    note the goal of the stimulus is to reduce the negative impact, not to generate a positive fiscal impulse.

    table 2/ p. 25 has the authors (a who’s who at the fund) proposed fiscal stance for Japan. There is a 0.5 pp of GDP consolidation in 17. And, then, bizarrely, a pause in 18 (why not in 17? my guess is that the Fund thinks establishing credibility is more important than the demand drag, but who knows?). And then steady 0.5 reductions in the out years. I should have noted the pause in 18. But the call for consolidation in 17 still seems strange to me.

    I assume the fund is assuming that the impact of its proposed incomes policy offsets the current account impact of their consolidation; otherwise it is strange to think that a 2 pp change in the fiscal balance has no impact on the current account

  • Posted by brad setser

    A general point on Japan. Because Japan has relied heavily on “temporary” stimulus packages in the past, the roll-off of past stimulus packages creates a tendency toward consolidation. New stimulus packages have to be passed just to avoid consolidation; they do not necessarily generate a positive fiscal impulse. This is a source of constant confusion. The IMF’s preferred fiscal path (from the working paper) thus has a different pace of consolidation than the “current policies” path from Japan.

  • Posted by jacopo

    In terms of the WP (Reflating Japan : Time to Get Unconventional? ) if one compares Table 1 and Table 2, the average net lending is about 0.4 percentage point lower at the policy package than the baseline. Hence, the authors argue for a fiscal expansion amounting to about 0.4 percent of GDP. This can also be seen on Table I.1 (page 33) when they describe the policy package: they have additional targeted transfers of between 0.8-1.6 % of GDP, while the 0.5pp increase in VAT amounts to around 0.25pp contraction. Overall, there is a fiscal expansion in their proposal. They also have a small monetary easing as well as an incomes policy (by raising minimum wages, private sector wages).

  • Posted by jacopo

    I do not think in para 21 they define near term as 2016: fiscal policy cannot even adjust 2016; it is almost gone; near term must mean 16-18 (as the next budget will affect 2018), at least in my reading. Anyway, I am not fully convinced that the IMF is not advocating for a fiscal stimulus for the coming years.

  • Posted by Brad Setser

    jacopo — I agree that the A4 was a bit confusing. paragraph 21’s time frame is not clearly defined, and the message is a bit at odds with the general call for 0.5% of GDP a year in tightening starting as soon as possible. the balance between the timing of the stimulus v the rolloff of old stimulus and the tax hike is unclear (though the press release emphasizes the need for a credible medium term fiscal package, not the need for shor-term stimulus).

    hence i think we need to look to the WP to get a clear sense of the IMF’s recommended fiscal path. And the WP makes it clear that the net fiscal consolidation over four years should be 1.5% of GDP (the increased transfers offset the rolloff of existing stimulus in 16 i think and seem to fully offset the hike in consumption tax in 18, but there is a NET consolidation of 0.5 in 17, and again in 19 and 20). Relative to the “current policy” baseline there may be less consolidation (the current policy baseline assumed a ’17 consumption tax hike, which isn’t happening). But on an absolute basis, the recommended path of the IMF (table 2/ p.25 of the WP) clearly is for further consolidation, and thus fiscal policy would be working against monetary policy.

    the increased transfers outlined on p.33 are temporary, and they do not fully offset the rolloff of past stimulus and the rise in the consumption tax (0.5 a year over 4 years, and continuing far off into the unknown). I grant that the IMF wants some offsets, but directionally, the IMF pretty clearly signaled they want consolidation, and they didn’t clearly signal that it was ok to do zero in 16, 17 and 18 as they didn’t propose fully offsetting the proposed hike in the consumption tax.