Must-Read: Brad Setser: IMF Cannot Quit Fiscal Consolidation (in Asian Surplus Countries)

Must-Read: Ummm… Maury… What’s going on in there?

Brad Setser: IMF Cannot Quit Fiscal Consolidation (in Asian Surplus Countries):

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…. 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….

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)…. That isn’t exactly a call to use the fiscal arrow to relaunch Japanese demand growth….

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…. And what of Korea?… 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)….

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.