The risks of debt deflation and disorderly sovereign and private-sector defaults are rising because policymakers are pressing ahead with spending cuts and raising taxes before seeing strong signs of an economic recovery, economist Nouriel Roubini wrote in a commentary piece for Project Syndicate.
Many European countries plan to push through large spending cuts and tax increases next year to cut their high levels of debt.
Rather than pushing spending cuts through in the short term, advanced economies should back-load the cuts if they want to avoid tipping back into recession, Roubini said.
“In an ideal world…the optimal and desirable path would be to commit today to a schedule of spending reductions and tax increases, phased in gradually over the next decade as the economy recovers,” Roubini said.
By planning fiscal savings over the medium term and foreseeing short-term additional stimulus when necessary, the United States and European economies could avoid the prospect of a “deflationary and recessionary spiral”, he said.
But “financial markets don’t care that front-loaded fiscal consolidation is exacerbating recession and thus making the goal of reducing debt and deficits as a share of GDP near-impossible to achieve,” Roubini said in the piece published on Monday.
Highly-indebted nations must be seen to be addressing their budget deficit, or risk being attacked by the debt markets.
Roubini argued the European Central Bank should ease monetary policy in order to weaken the value of the euro.
Meanwhile, Germany should cut taxes temporarily – rather than raising taxes, as planned – in order to increase disposable income and stimulate German demand for goods and services from the struggling peripheral euro zone countries.
“Alas, neither of the two biggest players in the euro zone is pursuing policies consistent with restoring sustained growth in the euro zone’s periphery…Thus, the periphery is destined to a destructive deflationary and recessionary adjustment that will exacerbate the risks of recession, insolvency, eventual defaults and, possibly, exit from the euro,” Roubini said.
In the UK, “massively front-loaded austerity” could lead to a double-dip recession, he said.
He also lamented the approach taken by US policymakers, saying “in the US, we have the worst of all possible worlds”.