I talked about this before, but not in detail. Last September a roundtable meeting organized by a Brussels based think tank and IMF was held with limited participation.  IMF delivered two presentations on the domestic demand stimulating measures that should be implemented to tackle the global crisis. The Fund declared that it supports these measures. Also the Chief of IMF made an evaluation.

Some academics and former bureaucrats from some Central and East Asia (including those from Hungary) criticized the IMF. These criticisms mainly read: "What on earth are you doing? You cannot give this card to the politicians. They will immediately increase spending and disturb budget balances." They recommended the opposite: to secure budget discipline, improve the confidence in the economy and thus provide people with an environment to increase consumption in turn.

The response by the IMF officials that worked in Turkey branch for a long time was quite interesting: It was sure possible to grow by ensuring fiscal discipline. There were examples to this in history. The most recent example was Turkey who achieved high growth during the program implemented after the 2001 crisis. But now, in 2009, things were different. States, who, could had to increase spending without disturbing the medium term fiscal balances in order to boost domestic demand. The response of the chief of IMF to the criticisms was even more interesting: Yes, it is possible to see a flying fish; but it is quite rare. You can read this after replacing the 'flying fish' with 'tight fiscal policy that enables economic growth'.

It appears that the EU, particularly Germany, is not a big advocate of making concessions to budget discipline. Their sensitivity in this respect can easily be realized from the speech Merkel did in the last G-20 meeting which read: "Growth cannot come at the expense of budget discipline." There are many economic programs that secured rapid growth through steep reductions in budget deficits. A number of academic research was made on this subject. As the literature suggests, in order for reductions in public expenditures and rises in tax revenues to boost economic growth, fiscal discipline must be sharp, to begin with. Second, in order for this striking transformation in fiscal policy to eliminate the risk perception, existing risks and the resultant lack of confidence shall mainly be a result of distorted fiscal policy. In this context, if high public debts lead risks in the economy to elevate considerably and pushed real interest rates up to astronomic levels, fiscal discipline that reduces public debts sharply can eliminate the risks. As a result, real interest rate drops rapidly.

Domestic demand can be stimulated through more than one channel: the Treasury sells fewer bills as borrowing requirement decreases. This way, banks have the potential to extend a higher amount of credits to the real sector. The improvements in confidence and drops in risks in such a milieu allow banks to make use of this potential. The same milieu first brings suspended consumption expenditures into the picture, and then investments move up. Demand for credits also increases. Thus, the third result the literature reaches is: in order for consumption and investments to increase, credit system has to become operable. Then, is it possible to see a flying fish in such an environment? Can fiscal discipline make a positive contribution to growth? This is a tough question. However, the milieu in Greece for instance is suitable for securing such outcomes: they have high amount of debt, high interest rate, and high budget deficit. Therefore, risk perception against Greece is also high. A credible fiscal discipline and substantial amount of low-interest foreign funds could have improved the confidence in the economy. I said it could have, because first, it was too late when the program was introduced, and second the Greek people do not have confidence in the program let alone the others.

So, can Germany or Italy benefit from this potential? This question is even tougher. However, in the light of the diagnosis of the mentioned literature, we can say that this potential is much stronger for Italy. I do not think we can say the same for Germany. Let me give an example from Turkey to clarify my statement. After the 2001 crisis, we had no option but fiscal discipline in order to ensure economic growth. On the other hand, growth could not be attained via an additional fiscal discipline in the second half of 2008 and the first half of 2009. Evidently, the fact that accelerating growth via fiscal discipline is not a possibility for Turkey in 2008-2009 or for Germany today does not imply that fiscal discipline is of no importance. I do not know any country that can ensure sustainable growth by permanently disturbing the fiscal discipline. What I imply here is that the idea reading 'we will ensure fiscal discipline to improve the confidence to economy and then enjoy growth' is not necessarily true. It depends on the circumstances.

This commentary was published in Radikal daily on 10.06.2010