Committee for a Responsible Federal Budget

The U.S. Needs a Fiscal Turnaround

Feb 23, 2010

The United States is not the first nation to face tough fiscal challenges. Other countries have faced similar fiscal challenges – and gotten out of them.

In a new paper ("Fiscal Turnarounds: International Success Stories"), CRFB’s Fiscal Roadmap Project looks at successful fiscal turnarounds around the world and possible lessons for the U.S.

What are the lessons?

- Large, multiyear adjustments have been more successful.

- An emphasis on spending cuts often - although not always - had the best results. To explain what worked and what didn't, it is important to look at the starting point. Many of the countries started with extremely high spending levels, so lower spending most certainly had positive effects by “crowding in” private demand. Many of the countries also had extremely high tax levels, so raising taxes even more would probably have been counterproductive. In countries where the initial conditions are not as tax and spending heavy, there is more room to raise revenue. (In the end, however, the design of the tax system is always critical.)

- It is also important to adopt other economic policies supporting the fiscal turnaround at the same time. Among the most important policies are: having credible fiscal rules and fiscal goals in place to help maintain discipline and stimulate an active public conversation; allowing the central bank to follow a strong anti-inflation policy; pursuing an appropriate exchange rate policy; and maintaining open trade and capital markets. These economic policies reinforce and are reinforced by the turnaround. 

- A public dialogue is critical in building support for a fiscal turnaround. Particularly in Canada and Sweden, the government took great care to educate the public about why large fiscal adjustments were in both their interest and the national interest – and why there was no realistic alternative.

The experiences discussed offer a cautionary tale to U.S. policymakers of the risks of not taking timely, appropriate action. Countries with severe fiscal and macroeconomic imbalances which have tried to muddle through circumstances similar to those now facing the United States were, in the end, forced to make dramatic fiscal adjustments by a crisis or by the threat of a crisis. It is always better for policymakers to take action on their own terms.