There's a good side to any crisis. It offers an opportunity for collective learning, although this requires a careful analysis of the causes. The alarmingly high national debt many countries now hold, as compared to gross domestic product, is by no means simply a result of fiscal countermeasures taken after the global financial crisis of 2008-2009. It is just as much a product of a policy, carried out for decades and widely accepted, of perpetually borrowing money for public budgets.
At this point, it's not a matter of returning to a well-defined normal state, but rather of a fundamental reevaluation of national debt. We're facing a paradigm shift in fiscal policy, just as monetary policies experienced a shift in the 1980s, when inflation was discredited. In this case, the force behind the change is capital markets.
The latest reaction by investors is indeed driven by the development of national debt over the last three years, but it also reflects debt burdens from the past. This can be seen clearly in the markets' shift from a longtime policy of debt tolerance to an extreme, and to some extent exaggerated, intolerance of debt.
It's necessary to take note here of the insufficient processing of information in the financial markets. Markets did not continually adjust their ratings, as theory suggested. This meant that the debt-GDP ratio -- the amount of debt in relation to economic performance -- increased for decades, sometimes remaining for long periods over 90 percent, the point considered the limit between debt tolerance and intolerance.
Now, a switch has been thrown. Rather than being sanctioned by ongoing adjustments to stipulated risk premiums, markets are being driven far more by specific events and moods. As a result, the provision of liquidity, something which was offered readily in the past, can collapse abruptly.
Such situations can easily lead to exaggerations, but without these casting fundamental doubt on this reevaluation. This type of market reaction can't be addressed with isolated measures and we've seen evidence of this in the past weeks. Politicians have grown increasingly serious about tackling national debt, but this has only ever had a temporary calming effect, before markets then displayed an even more nervous reaction.
Investors are pushing politics toward a fundamental reevaluation of national debt. In this context, our path out of the debt crisis should be informed by three questions:
- What fiscal policies are appropriate in the event of serious economic upheaval?
- What fiscal policies are needed for normal economic cycles and in order to carry out government responsibilities in the long term?
- What institutional innovations are necessary to provide financial markets with reliable orientation?
Despite the developments of these last weeks, it still holds true that in serious global crises, such as the abrupt and systematic disarray that occurred in 2008 and 2009, fiscal policy should approach the crisis with a coordinated, expansive strategy, providing markets with sufficient liquidity. Still, the success of such crisis policies depends on a reliable ending, which is the source of the wisdom that economic stabilization policies should be avoided in normal cases.
A principle of avoiding new debt gains credibility through corresponding institutional controls, such as constitutionally stipulated debt limits. Only then is it realistic for a democratic country with a large-scale, systematic inclination toward redistributing wealth to promise lastingly sound public finances -- just as the presence of an independent central bank makes it realistic to promise stability.
Financial markets demand such institutional controls. These offer protection for restructuring programs, as well as helping to make them more persuasive. The relative winners in this fiscal competition will be those countries that, like Germany, took early action and have already introduced a constitutional debt brake.
Such restructuring can't be achieved in just a few quarters, and of course it also requires country-specific solutions. It's certainly valid to ask whether the Bush administration's tax cuts perhaps caused permanently insufficient funding in the United States' national budget, creating the current problems. In any case, important information should be delivered to financial markets in a timely manner. This includes, especially, a quickly achieved surplus in the primary budget -- in other words, in revenue before the payment of interest.
Still, consolidation programs alone are ineffective without institutional commitments from the political arena. And it is in this sense that there's certainly a good side to the debt crisis.