PARIS, JULY 16, 2010: GOVERNMENT policies that target fiscal consolidation with structural reform can perform better to sustain growth and reduce global imbalances rather than policies aimed only at fiscal consolidation.

To contribute to the G-20 process, the OECD simulated the effects of three policy scenarios; business as usual, fiscal consolidation and fiscal consolidation with structural reform in order to identify the policies most likely to successfully deliver strong balanced growth, sound public finances and sustainable current account positions, for the period 2012-25.

The study showed that the implications of business as usual policies would result in gradual fiscal consolidation, high government indebtedness, which would dampen medium-term growth prospects resulting in rise in long term interest rates, posing risks to future stability. Also, a higher cost of borrowing would impact business investment and global imbalances would emerge as global demand recovered and output gaps closed.

A fiscal consolidation scenario involved sufficient fiscal consolidation starting in 2011 to reduce government debt in relation to GDP by 2025 to the pre-crisis levels prevailing in each OECD region. This scenario focussed on efforts to restore the longer-term sustainability of OECD public finances, with consequent depreciation of OECD currencies vis-à-vis their non-OECD counterparts.The impact of such a scenario would help to reduce the ratio of government indebtedness to GDP by 2025 to pre-crisis levels with a limited impact on external imbalances, partly because all OECD economies would have engaged in consolidation simultaneously. Such policy measures were expected to lead to improvement in medium term growth outcomes. However, fiscal consolidation would sap demand in the short term and, hence, lower GDP growth in 2011-12, depending on the extent of the required adjustment in individual countries.

Fiscal Consolidation With Structural Reform

In the scenario of fiscal consolidation with structural reform,fiscal consolidation would include stylized structural reforms which would gradually reduce savings in countries with large current account surpluses and discourage consumption in deficit countries. Such policies were expected to impact an improvement in financial market regulation, elimination of distortionary tax incentives and also reduce unemployment. Over the longer term, global output was expected to be higher with a reduction in global imbalances. Thus, this method would be expected to have the most beneficial impact on world economies.