Don’t Prime the Pump, Plug the Deficit : Economy: It’s not tight monetary policy, but weak fiscal and structural policies that are hindering growth.

In an address Tuesday to the board of governors of the International Monetary Fund and the World Bank in Washington, Michel Camdessus, IMF managing director, talked about the end of “the days of hegemonies” and of a new era of global interdependence. Among problems that jeopardize the potential of this new era, he cited financial instability in industrialized countries. Following are excerpts:

The prospects for the future will be brighter if the industrial countries pursue monetary policies that consistently keep inflation low, fiscal policies that achieve budgetary balance over the cycle and structural policies that enhance the growth of employment and productivity. In fact, the measures needed now to boost confidence and re-establish stability in the markets are precisely those that also have the potential to promote non-inflationary growth and create jobs.

To create jobs. The industrial countries are anxious to find more effective ways to tackle the unemployment problem, which threatens to erode the basic fabric of their societies. But, after all the efforts of so many years, what is missing from their economic strategy?

Some will tell you that it could be safe now to relax monetary discipline and so give a boost to activity, because inflation has been subdued, if not quite defeated. But this would be the most serious mistake we could make today. It is not tight monetary policy, but rather the weakness of fiscal and structural policies that has undermined confidence, resulted in high long-term interest rates and hindered growth. If this is true, the industrial countries should implement the medium-term strategy more effectively, not abandon it.

Let us start with the most basic tenet: fiscal consolidation. Everyone recognizes the central importance of this, to free savings for productive use and bring about a reduction in long-term interest rates. But is it sensible to take firm action to reduce fiscal deficits while the recovery is still so hesitant? I recognize this concern. Nevertheless, my answer is a firm yes. Yes, because each postponement of long-overdue fiscal action adds to the severity of the problem. Any further postponement of fiscal retrenchment out of concern for possible short-term effects on activity would contribute to a worse environment rather than a better one.

Credible action to reduce budget deficits would improve confidence, lower inflationary expectations and produce a downward adjustment of long-term interest rates. All these would, in time, more than offset any short-term contractionary impact. The main emphasis should continue to be placed on expenditure restraint but increases in revenues will also be necessary, in several countries.

I urge prompt action to ensure speedy and lasting fiscal consolidation in the United States and Germany. I would also recommend firm fiscal action in other European countries, most notably Italy. I applaud the prudent fiscal policies that Japan has followed for many years.