The cumulative steps taken by Euro Area countries over the past several years have greatly reduced the fiscal sustainability problems on the continent. The International Monetary Fund (IMF) estimates that ⅔ of Euro Area countries have already done enough fiscal adjustment (through end of 2013) to achieve debt sustainability and debt reduction (IMF 2013b, 8). This fiscal consolidation although enormously painful has, in conjunction with reassurances offered by the European Central Bank (ECB), helped restore confidence in the Euro Area even as concerns about individual countries and banks remain. Indeed, as the uncertainty evoked by the Cyprus rescue effort illustrated, continued careful management of conditions at both the country level and the regional level is required.
Much of the uncertainty that surrounded U.S. fiscal policy toward the end of 2012 has dissipated. Congress has twice extended the debt ceiling well in advance of reaching it, reducing the likelihood that a return of brinkmanship will cause the debt to go unpaid. The decision to allow payroll taxes to expire and increase tax rates on some wealthier individuals, together with the spending cuts associated with the sequester have reduced the U.S. general government deficit by an estimated 1½ percent of GDP.
Nevertheless, little progress has been made toward setting U.S. fiscal policy on a sustainable medium-term path. At 7.0 percent of GDP in 2012, the general government deficit remains very high, and gross general government debt is projected to reach 107 percent of GDP in 2013. As a result, the IMF (2013b) estimates that an additional deficit reduction of some 8.2 percent of GDP will be required before fiscal policy in the United States returns to a sustainable path (almost twice the estimated cuts required in the Euro Area). In Japan, the same number is more than twice as high again, even when seeking the less ambitious objective of reducing general government gross debt to 173 percent of GDP.
Traditional risks have receded, but other risks and challenges have emerged or grown in stature
Even as the post-crisis risks from the high-income world have declined in importance, a new set of uncertainties and risks are emerging or gaining in stature. For instance, developing countries are increasingly concerned about:
- the potential effects of the radical relaxation of both fiscal and monetary policy in Japan;
- the potential impacts on revenues, government balances, and growth among commodity exporters, if the increased supply and demand suppression that high commodity prices have evoked begins to generate strong downward pressures on commodity prices;
- domestic challenges, including inflationary pressures and asset price bubbles, and weaker than pre-crisis growth rates.
- The challenges that the eventual withdrawal of quantitative easing may bring.