WASHINGTON Countries looking to get their finances in order should not act too quickly to enact budget cuts, but should weigh investor confidence in their bonds, International Monetary Fund staff said in a wide-ranging paper on Tuesday.
Still, the paper, which sums up lessons learned about fiscal policy from the global financial crisis, says the evidence is inconclusive, and the paper offers little in the way of concrete guidance for governments struggling to decide how to get their finances in order.
The proper pace of budget cuts is likely to be in focus during meetings of finance ministers and central bankers from the Group of 20 biggest economies in Washington next month.
"The optimal pace of adjustment depends on the state of the economy, the condition of public finances and the extent of market pressures," the staff said in the paper.
The IMF added that even for countries battling to retain investor confidence, "speed limits" on consolidation may be a good idea to avoid crimping growth to the point that any reduction of debt to GDP would be counter-productive.
The 2007-2009 financial crisis and global recession overturned many common assumptions about the timing of credible austerity programs, safe levels of debt, and the impact of fiscal stimulus. Previously, the consensus was that the sooner governments reined in their debt, the better, the IMF noted.
The IMF came under heavy criticism last year when it conceded that austerity programs it recommended during the global crisis were more costly than expected, causing economic damage that was as much as triple the amount forecast.
The IMF's admission provided fuel for critics of steep budget cuts in debt-burdened European economies, and prompted the IMF to soften its own recommendations for the euro zone.
However, in the paper released on Tuesday, the IMF said countries that have lost the confidence of bond investors may have no choice but to cut their debt quickly. At the same time, waiting too long to consolidate could also hurt, if markets lose faith the government will eventually get its finances in order.
The IMF said governments that can afford to wait should aim for that golden "medium-term" austerity, but also do a few small measures immediately to prove they are serious about cuts.
"Country authorities will never be in a position to know for sure whether a slightly more gradual adjustment path than that opted for would have been accepted by markets or would have led to a collapse of confidence," the paper said, adding that most austerity would likely hurt growth in the short term.
On the other hand, the crisis showed fiscal stimulus can be effective in boosting the economy during a severe recession, especially when interest rates were already close to zero.
Central bank purchases of government debt also helped revive financial markets, the paper said, even though some had worried such purchases would be viewed as a "monetization" of government debt, undermining the credibility of monetary policy.
As long as investors believed the government was still serious about cutting its deficits eventually, bond buying could work, the IMF said.
The IMF said one firm conclusion from the crisis is that countries need to maintain lower levels of debt than previously thought, so they can respond in the event of future shocks.
"The emerging post-crisis consensus suggests lower values for what constitutes 'safe' debt-to-GDP ratios, to account for much-larger-than-imagined macroeconomic shocks and contingent liabilities," it said.
Governments should also pay attention to the level of debt in the private sector and in regional and local governments, something that will require better fiscal transparency.
The IMF said the crisis did not resolve why countries viewed as safe havens, such as Japan and the United States, can maintain high debt levels without affecting market access, and left open the question of how long this could last.
(Reporting by Anna Yukhananov; Editing by Leslie Adler)