Adjustment programs in debt-hit euro area countries would run more smoothly if governments implemented structural reforms to boost productivity, according to a staff discussion note published by the International Monetary Fund (IMF) on Tuesday.
The document – which is titled "Deficit countries: Progress, challenges, and policies" and which is not an official IMF report – stressed that achieving internal devaluation in the economies of the periphery (Greece, Ireland, Portugal and Spain) “hinges on depreciating the real effective exchange rate through lowering nominal wage growth and/or improving productivity relative to trading partners.”
The report – prepared by Thierry Tressel, Shengzu Wang, Joong Shik Kang and Jay Shambaugh – noted that past experience indicates that achieving internal devaluations can be a long and painful process in an environment with wage rigidities. Similarly, internal devaluations can be difficult when trading partners’ inflation is low and may exacerbate debt overhang problems.
IMF experts said structural reforms, instead of additional wage cuts, were necessary to remedy the situation.
“While productivity improvements would have the same effect on inflation as nominal wages cuts, they appear more desirable in the medium term as they boost demand,” they said.
Debt-hit countries have so far combined relative price adjustments, achieved mainly by compression of internal demand and labor shedding, and structural change, the note said. Progress remains limited as although exports have rebounded, manufacturing sectors “typically remain smaller than before the crisis,” it said
“The large current account deficits in Greece, Ireland, Portugal, and Spain have shrunk drastically or turned into surpluses largely because imports and potential growth have slowed down drastically relative to precrisis trends.”
Authors said that macroeconomic policies, structural reforms, and policies to complete eurozone integration were critical to advance adjustment.
In the short term, the authors said, supportive macroeconomic policies “would help support domestic demand and facilitate relative price adjustments.”
In the medium run, further structural reforms in product and labor markets are needed to raise productivity and lift potential output growth.
“In the future, elements of a Fiscal Union would also help facilitate adjustment across member states,” the note said.