HSBC - Macro - The long-term costs of today's fiscal excess

HSBC - And when the money runs out? The long-term costs of today’s fiscal excess

Fiscal austerity will place a huge constraint on any future recovery
The UK and the US have the biggest problems
Fiscal frailties threaten currency crises, price instability and default

Policymakers may have prevented another Great Depression but their work is not yet over. The fiscal arithmetic now looks awful. During the boom years, the US and UK governments in particular chose not to put money aside for a rainy day. Now, the numbers simply don’t add up.

At the very least, governments need to pursue a multi-year period of fiscal austerity. Even that, though, may not be good enough to stabilise the fiscal outlook. Credit booms tend to leave countries with permanent activity losses, undermining a government’s ability to raise revenues to support public services. And, even if productive potential were to be untouched by the crisis, governments still face problems. The number of higher rate tax payers will shrink in response to a diminishing financial sector. Ageing populations will place tremendous pressure on some governments to raise healthcare and pension outlays.

What, then, can governments do? Austerity is politically unpopular and difficult to sustain for more than a handful of years. Other options to reduce the fiscal burden, though, create their own difficulties. For the US and the UK, printing money is an attractive wheeze because, with so much spare capacity, the benefits should be felt via higher output rather than elevated inflation. Foreign purchasers of Treasuries and gilts, though, would take a hit via falls in the dollar and sterling, raising the risk of major currency crises. Meanwhile, for those countries without access to their own printing press (most obviously those in the eurozone), default risk might eventually rise. More generally, in the absence of credible austerity measures, quantitative easing is going to be around for a very long time: any exit which led to higher bond yields would seriously upset both the fiscal arithmetic and the sustainability of any economic recovery