II. Challenges Facing the Global Economy
But let me begin with three major challenges that I see facing the global economy today:sovereign debt, growth, and social instability. These challenges are intimately intertwined—and Iwill submit that it is only by solving all three that we can unlock strong, stable, and balancedglobal growth. Why is that? Because for sovereign debt to be sustainable, economic growthneeds to be strong, but in a sustainable way. And for economic growth to be sustainable, it needsto deliver the stable social chemistry that holds societies together.
Let me turn to the ﬁrst challenge—sovereign debt.
In Europe, ﬁscal problems in the periphery have revealed the risks posed by an incompleteeconomic and monetary union. As a result, the euro area as a whole is experiencing difﬁculties.Even the tough ﬁscal and structural measures adopted by the affected countries have notconvinced markets that a lasting solution is in place.Last week, eurozone leaders reached an important agreement to overcome these concerns. Thepackage includes new ﬁnancing for Greece, at much longer maturities and lower rates—termsthat will also be available to the other crisis economies. The EFSF—Europe’s crisis ﬁnancingtool—has been given greater ﬂexibility in supporting member countries. The package alsoincludes critical measures to strengthen economic governance in the eurozone.The agreement shows that European leaders believe in the eurozone, and will do what it takes tosecure its destiny. It has been welcomed by ﬁnancial markets, as reﬂected in the stronger euroand lower peripheral bond spreads. But turbulence could easily resurface. For this reason, it isessential that the summit’s commitments should be implemented quickly.I’m hopeful that the political courage shown by European leaders will soon be followed by boldﬁscal action in the U.S. On the debt ceiling, the clock is ticking, and clearly the issue needs to beresolved immediately. Indeed, an adverse ﬁscal shock in the United States could have seriousspillovers on the rest of the world. But more fundamentally, a credible ﬁscal adjustment plan isneeded sooner rather than later. In Japan also, even though the situation is not as urgent, moreambitious measures are needed to deal with the very high level of public debt.What will ﬁscal consolidation mean for growth? In the short-term, the impact is likely to benegative. Our research has found that a 1 percentage point cut in the deﬁcit could lower growthby about
percentage point over two years. This is why measures that are legislated now—butonly reduce deﬁcits in the future, when the recovery is more robust—would be particularlyhelpful. But there is good news too: over the longer term, debt reduction can actually raise outputby bringing down real interest rates and making room for tax cuts.