Trichet Calls for ‘Ambitious’ Debt Reduction

While a great deal of attention has been given to Federal Reserve Chairman Ben Bernanke’s address in Jackson Hole, Wyoming on Friday, the remarks provided that day by his trans-Atlantic counterpart, European Central Bank President Jean-Claude Trichet, deserve equal, if not more, attention. Trichet highlighted the need for “ambitious” fiscal consolidation in promoting the global economic recovery.

Trichet said that the debt overhang among families, the public and private sectors is primarily responsible for the slowing down of the economic recovery. He argued against using inflation to solve the debt overhang, saying that such a policy “has been disastrous everywhere.” He also dismissed “living with the debt” in order to pursue economic stimulus in the short term. He pointed out Japan’s “lost decade” in the 1990s as an example of the failure of ignoring imbalances. Trichet contended that addressing the debt will promote growth and that strong growth will, in turn, make it easier to reduce the debt.

He acknowledged that reaching the target of a 60 percent debt-to-GDP ratio (as the Peterson-Pew Commission on Budget Reform also recommended in the report, Red Ink Rising) will require sizable decreases in debt, but said that such reductions “are not uncommon and quite feasible.” He provided post-war United Kingdom, Belgium in the late 1990s and 2000’s, Ireland, Spain, the Netherlands and Finland in the mid 1990s as examples. He also made it clear that he was “skeptical” of arguments that fiscal consolidation could severely harm the fragile economy. Rather, Trichet maintained that timely fiscal consolidation would strengthen the economy, while delay would be costly.

He reaffirmed the ECB’s membership in CRFB’s “Announcement Effect Club” by reasoning that announcing a credible fiscal plan now would aid the economy by removing uncertainty that debt will be addressed.

Timeliness does not necessarily mean that all measures are implemented immediately. Rather, it implies that a credible long-term plan is announced in time. Although fiscal adjustment itself may be gradual, it is important to announce a credible road-map for fiscal consolidation as soon as possible. With a credible road-map, and a consistent step-by-step implementation of the consolidation measures that it involves, the uncertainty diminishes or perhaps even vanishes completely. As a consequence, fiscal consolidation pushes the economy towards a durable recovery.

We completely agree.