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IMF argues no pain no gain in fiscal fitness

President of Greek truck drivers union Giorgos Tzortzatos tries to calm down his colleagues during a protest outside the Greek Parliament in Athens last week.

(Photo Credit: AP Photo/Thanassis Stavrakis)

By Howard Schneider
The widespread budget cutting by developed countries in recent months will sap economic growth for years and keep unemployment high, the International Monetary Fund said today in a study. The results are likely to stir debate about whether it was a good idea for the world's major economies to try to reduce their government deficits all at the same time.

The fact that countries are cutting simultaneously, with interest rates near zero, means some of the traditional mechanisms available to cushion a drop in government spending will not be effective. Countries such as Greece and Ireland are already suffering the absence of one such safety valve. Because they belong to the euro area monetary union, they cannot devalue a local currency to boost their exports.

In such an environment, the impact of deficit reduction will be even more painful than it would be otherwise -- and could subtract more from a country's gross domestic product than the amount trimmed from the deficit. Under usual circumstances, a deficit cut equivalent to one percent of a nation's GDP trims about half a percentage point from economic growth. In the current situation, the authors of the study said, the cost to growth may more than double.

It also may take as long as three years for growth and employment to rebound from that shock, and as many as five years for a country to "break even," the study concluded.

How fast and deep to cut budget deficits has been a central topic for U.S. and European leaders as they try to nurture an economic recovery but also temper public debt that has reached historic -- and some argue unsustainable -- levels.

The IMF has encouraged "fiscal consolidation" -- reducing national deficits and debt accumulation. But today the global finance overseer made its most definitive statement yet about the social costs involved.

"It is necessary and unavoidable. The question is, will it hurt?," study author Daniel Leigh said at a news conference. "We should not kid ourselves. In the short term, tax hikes and spending cuts will reduce growth and raise the unemployment rate."

By Howard Schneider  | September 30, 2010; 11:10 AM ET
Categories:  International Monetary Fund  
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So, what's the alternative, just keep spending?

Posted by: Anonymous | September 30, 2010 6:25 PM | Report abuse

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