The Fed meets today, but nobody expects them to do much of anything. The general consensus is that it will be ages before Bernanke & Co. even hint at raising interest rates.
But the IMF is out with a stark warning to governments all around the world. The organisation says they must get serious about pulling back the stimulus, both monetary and fiscal. And they’re serious. (via FT Alphaville)
New IMF research on government debt, deficits and interest rates. Fiscal deficits and
government debt levels both affect interest rates. Stabilizing debt at post-crisis levels
would imply higher interest rates (perhaps by 2 percentage points). Moreover, there are
important nonlinearities: the impact on interest rates of each additional percentage point
of debt or deficit increases as the initial debt or deficit level rises, pointing to a risk that
government debt could snowball without corrective action. This underscores the need for
governments to announce credible exit strategies now, even if it is premature to begin
exiting from fiscal support.
A “fiscal exit strategy” limited to unwinding discretionary fiscal stimulus and
financial sector support would be far from sufficient. As discussed above, simply letting
the stimulus expire would still leave the government debt of many advanced countries on an
explosive path. While maximizing the recovery value of assets acquired through financial
sector support is important, it will not materially alter the medium-term outlook, as the
receipts would be small compared to the overall projected increase in gross debt (Cottarelli
and Viñals, 2009).
Even stabilizing debt ratios at their post-crisis levels is not enough:
Living with high debt would reduce the capacity of fiscal policy to respond to future
shocks. Indeed, the fiscal stimulus during 2008–10 was inversely related to the level of
public debt, at least in large countries.1
High debt would likely lead to high real interest rates. New evidence on the effect of
fiscal variables on interest rates shows that a one percentage point increase in the fiscal
deficit raises long-term government interest rates by 10 to 60 basis points (Appendix).
The analysis also finds that long-term rates rise by five basis points for each 1 per cent of
GDP increase in the government debt stock. This implies that the 40 percentage point
increase in government debt ratios projected for advanced countries during 2008–14
could raise interest rates by two percentage points. The effects are even larger for
countries that start from high debt ratios or deficit levels, or that confront faster