The International Monetary Fund's chief economist cautioned on Wednesday against imposing tough austerity measures too quickly and instead favors a longer process as countries around the world grapple with high debt levels.
The IMF's Olivier Blanchard said he was surprised over the debate over whether the best way forward was more stimulus to boost economic growth or tighter measures to deal with deficits, saying in most circumstances austerity would lead to contraction.
The hope that fiscal consolidation will make people optimistic about the future and lead to a boom in the economy next year I think is something we should give up, said Blanchard, speaking on a panel at the Council on Foreign Relations in New York.
Blanchard noted that there are some dire situations that have been improved by greater government responsibility, but the United States and most of Europe are not in such bad shape as to warrant that.
It seems to me everybody should agree that the fiscal adjustment should be a long, drawn out, credible, medium-term process, said Blanchard, who also said austerity was clearly needed.
He said he was worried that governments feel pressure to satisfy markets through very strong and very fast fiscal consolidation.
The debate over whether economic policy should focus on spending more or spending less has been a heated one, particularly in the United States ahead of next year's presidential elections.
Wrangling over the budget has seen U.S. lawmakers gridlocked this year and the latest issue being debated is whether to extend a payroll tax cut and unemployment benefits that are set to expire at the end of the year.
Asked about the debt crisis in the euro zone, Blanchard said that if Europe does not contain its short-run crisis, clearly the world will be affected in major ways.
But even assuming the region is able to get its debt problems under control, next year is not going to be nice for Europe as bank deleveraging and fiscal consolidation will be a major drag on the economy.
As to the impact of the crisis on the rest of the world, There is enormous ambiguity, said Blanchard.
Last week, European leaders agreed to draft a new treaty for deeper euro zone economic integration as policymakers try to put a fence around the region's debt crisis to stop it from spreading.
Under the new treaty plan, the leaders agreed to pursue a tougher budget discipline regime with automatic sanctions for deficit sinners in the single currency area, though Britain refused to join in.
On Wednesday, Germany's chancellor and central banker rebuffed calls for greater intervention from the European Central Bank in dealing with the crisis, urging Europe to stick to stricter budget discipline.
Asked about how to address financial regulation, Blanchard characterized the subject as terrifying, adding there is a deep question as to whether good financial regulation can be designed.
Regulation of the financial system is a game in which you have people on the other side who are as quick or quicker than you are, and the system is constantly changing, partly on its own and partly because of the regulation, Blanchard said.
Whether you can ever solve it is a question I have.
(Reporting By Leah Schnurr; Editing by James Dalgleish)