Trichet Says Failure to Cut Government Debt Risks `Lost Decade'

European Central Bank President Jean-Claude Trichet said governments risk a “lost decade” of weak economic growth if they delay reversing the surge in public debt triggered by the financial crisis.

“The lesson from past history is that dealing with the legacy of accumulated imbalances is not simply a duty to be fulfilled after the economic recovery, but rather an important precondition for sustaining a durable recovery,” Trichet said yesterday in a speech at the Kansas City Federal Reserve Bank’s annual monetary symposium in Jackson Hole, Wyoming. “The primary macroeconomic challenge for the next 10 years is to ensure that they do not turn into another ‘lost decade.’”

Trichet’s call for immediate fiscal austerity comes three months after he sought to protect the euro area from a spiraling debt crisis. His view also clashes with President Barack Obama’s preference to focus on spurring growth.

Trichet’s speech maintained the policy of ECB officials not to discuss the economic outlook or monetary policy within a week of meetings by the governing council to set interest rates.

Focusing on the longer term, Trichet said debt among consumers, businesses and governments “bears the ultimate responsibility for slowing down the economic recovery” and that delivering stability and growth in the coming years would require a “progressive reduction” of it.

Europe’s Debt

By the end of this year, euro-area government debt will have risen 20 percentage points since 2007 with gains of as much as 45 percentage points in the U.S. and Japan, Trichet estimated. Reducing Europe’s debt to 60 percent of gross domestic product will require a 30 percentage-point drop, he said.

Without naming specific policy makers, Trichet said some have suggested the short-term economic outlook requires more spending and that debt can be ignored for now.

“Adopting this view would be very dangerous for our economies,” he said, drawing a parallel with Japan in the 1990s when banks contributed to economic weakness by rolling over the bad debts of inefficient firms.

High public indebtedness and the lack of a plan to pare it threaten to create uncertainty among households and companies knowing they would ultimately face the higher taxes and spending cuts needed to reduce it, Trichet said. A debt overhang can also prompt governments to adopt regulatory measures to compel banks and households to hold government debt, he said.

Not a Solution

“So the option of ‘living with the debt’ indefinitely is not a solution to the challenges currently facing policy makers, nor is it a means to ensure sustainable economic recovery,” he said. “Given the size of the accumulated public debt, fiscal consolidation will have to be ambitious.”

The White House projects the U.S. budget deficit will reach a record $1.5 trillion this year, or about 10 percent of the nation’s gross domestic product. President Barack Obama has ordered a three-year freeze in non-defense and national security programs in his budget released Feb. 1 and told some agencies to reduce their 2012 budget requests by 5 percent.

Trichet said he was skeptical of the argument that cutting back deficits now would risk derailing the recovery. Acting now would simply replace the future tax burden with the current one, and credible cuts through spending reductions could spur private sector confidence by lowering market interest rates and the threat of future tax increases, he said.

Retrenchment Period

The role of central banks during a period of fiscal retrenchment is to maintain their focus on delivering price stability, Trichet said. “Their roles as anchors of stability is all the more important in times of deleveraging,” he said.

Referring to how central banks have used a mixture of interest rate cuts and non-standard policies to fight the financial crisis and recession, he said their withdrawal could occur independently of each other. “Interest rate increases could perfectly well take place independently of the phasing out of the non-standard measures if those non-standard measures continue to be fully justified by the situation,” he said.

The Kansas City Fed is hosting central bankers from more than 40 countries including Brazil, Malawi and New Zealand this year as well as economists from firms such as Bank of America Corp. and Morgan Stanley.

Trichet has often used the gathering to flesh out his approach to monetary policy. Last year he sought to explain the ECB’s efforts to fight the financial and economic crises, defending his institution against criticism that it acted more slowly than other central banks.

In 2005 Trichet outlined his theory of “credible alertness,” arguing that central banks should commit to anchor inflation expectations and then take resolute action if price stability is then threatened.

To contact the reporters on this story: Simon Kennedy in Jackson Hole, Wyoming Frankfurt at 1980 or skennedy4@bloomberg.net

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