Posted by At least part of the reason that growth was challenged in 2010 and 2011 was that the handoff from the public to private sector did not proceed as smoothly as hoped.
Some argued that this sputtering proved that there would be no recovery without large increases in Government spending – and while it’s true that decreases in government spending typically decrease aggregate demand in the short run, it’s almost certainly untrue in the long run.
The good news for those concerned with the (short run) outlook is that global fiscal drag is going to slow in 2012.
Based on the Jan’12 update to the IMF’s fiscal monitor database, it looks like fiscal drag is going to subtract ~40bps from global GDP in 2012, down from ~100bps in 2011. Â The drop from -80bps to -40bps of global GDP between the IMF’s Sep and Jan forecasts is mostly due to the operation of automatic fiscal stabilisers (less growth means less drag).
There’s some chance that there is no (net) global fiscal drag in 2012 (there certainly will be some in some regions), as the US seems unlikely to do much consolidation.
The IMF has pencilled in ~150bps (of GDP) of fiscal drag for the USA in 2012, and there’s a decent chance that this doesn’t happen (as payroll tax cuts will almost certainly be extended, and unemployment insurance benefits may be extended). I will be surprised if the US achieves ~100bps of consolidation in 2012.
While a modest increase in EUR fiscal drag (the IMF has assumed 90bps in 2012) seems possible, it is unlikely to be sufficiently large to fully offset the likely reduction in US fiscal drag.
So, my policy outlook for 2012 has global central banks continuing to ease monetary policy and much reduced fiscal drag – that’s a combination that ought to bolster short term growth prospects.
ricardian ambivalence 