The fifth option is to tighten fiscal policy and reduce budget deficits with the aim of lowering the high interest rates that drive the inflows. But sounder fiscal policy might lead to even higher inflows as the country s external balance and sovereign risk outlook improve.

Fiscal Challenges and Fiscal Follies

A cyclical recovery is underway, supported by monetary easing for years to come and increasingly flexible fiscal rules. More risk sharing will start in the banking sector (with EU wide deposit insurance up next), and eventually more ambitious proposals for a fiscal union will be adopted.

To believe that any country issuing debt in its own currency is risk free as long as the exchange rate is flexible is astonishingly naive. For one thing, there is still inflation risk, particularly for countries with weak fiscal institutions and heavy debt burdens.

This is likely to happen soon. At this point, peripheral countries will regain their fiscal sovereignty and will be able to ignore Reinhart and Rogoff s warning at their own risk.

To this end, eurozone leaders must take three key steps. The dysfunctional system of European fiscal governance should be dismantled fiscal responsibility should be returned to member states and, to minimize the risk of excessive future lending, private lenders should be required to bear the losses implied by unsustainable sovereign debt.

Finally, in the face of political opposition to fiscal consolidation, especially in the US, there is a risk that the path of least resistance becomes continued monetization of fiscal deficits. Eventually (once the slack in goods and labor markets is reduced), this would push inflation expectations and yield curves higher.

To reduce the risk of financial pressures on Italy and Spain, both countries need to press ahead with fiscal austerity and structural reforms. Moreover, their debt could be ring fenced with a larger package of EFSF resources and or with the issuance of Eurobonds a further step towards European fiscal integration.

Not only is QE s ability to jumpstart crisis torn, balance sheet constrained economies limited it also runs the important risk of blurring the distinction between monetary and fiscal policy. Central banks that buy sovereign debt issued by fiscal authorities offset market imposed discipline on borrowing costs, effectively subsidizing public sector profligacy.

For the global economy, the malaise reflected in anemic trade growth calls for coordinated fiscal stimulus by the world s major economies. Otherwise, the risk of another global recession will continue to rise.

If America s Democrats lose in the mid term elections this November, there is a risk of persistent fiscal deficits as Republicans veto tax increases while Democrats veto spending cuts. Monetizing the fiscal deficits would then become the path of least resistance running the printing presses is much easier than politically painful deficit reduction.

And here was the clincher By committing themselves to fiscal tightening, finance ministers gave themselves scope for some fiscal loosening. Proclaiming fiscal virtue enabled them to practice fiscal vice.

Fiscal Follies

Of course, fiscal sustainability is vital to prevent a disruptive debt refinancing and inspire confidence among investors and consumers. But there is no denying that it is much easier to support fiscal austerity when one is wealthy enough not to rely on public services or be at serious risk of becoming mired in long term unemployment.

In striking the right balance between immediate economic stimulus and medium term fiscal sustainability, the most urgent step will be to counter properly the looming fiscal cliff, as temporary tax cuts expire and deep, across the board spending reductions kick in automatically. Failure to do so would significantly increase the risk of an outright American recession.

Systemic risk raises doubts about the solvency of over indebted countries, which means that these countries efforts to consolidate their fiscal position and promote reform do not lead to improvement in financial conditions, which is essential for overcoming the crisis and promoting recovery. As a result, fiscal consolidation becomes increasingly difficult to achieve, inviting renewed speculative attacks.

Some European academics tried to argue that there was no need for US like fiscal transfers, because any desired degree of risk sharing can, in theory, be achieved through financial markets. This claim was hugely misguided.

For example, Portugal s GDP was expected to grow by 1 this year in fact, it will contract by a stunning 3 . The European Commission s claim that this slowdown reflects high sovereign default risk, rather than fiscal consolidation, is belied by the UK, where the sovereign risk is deemed by markets to be virtually nonexistent.

Europe s Fiscal Wormhole

America s Fiscal Isolationism

Fiscal Apocalypse Now

Germany s Fiscal Follies

Greece has no good options, but a serious contagion risk remains to be contained in order to prevent derailment of the fiscal and growth oriented reforms in Italy and Spain. In the face of high systemic risk, private capital is leaving banks and the sovereign debt markets, causing governments borrowing costs to rise and bank capitalization to fall.

Computes Italian Fiscal codes

America s Exceptional Fiscal Conservatism

Europe s Empty Fiscal Compact

Fiscal Fibs and Follies

Gaming US Fiscal Reform

America s Fiscal Cliff Dwellers

Is Fiscal Stimulus Pointless?

Threading the Fiscal Needle

Fixing America s Fiscal Problem

e. Special fiscal policies

At the same time, the eurozone crisis remains unresolved, despite the ECB s bold actions and talk of a banking, fiscal, economic, and political union. Specifically, Greece, Portugal, Spain, and Italy are still at risk, while bailout fatigue pervades the eurozone core.

We do not know how to handle the fiscal issues posed by the financial crisis. Doubts about the sustainability of government debt produce sudden surges in interest rates, as risk premia rise dramatically with perceptions of the likelihood of default.

Fiscal Austerity Versus European Society

Fiscal Discipline and Educational Quality

Lessons from the Fiscal Cliff

Ireland s Moment of Fiscal Decision

The Bogey of Fiscal Stimulus

The Case for Fiscal Stimulus

The Fiscal Crisis Down Below

Will Europe s Fiscal Compact Work?

Fiscal year ending 30 September

Country Kazakhstan Fiscal year 2004