OECD government debt will grow for several years ahead and may increase from 80 per cent of GDP in 2008 to almost 120 per cent later this decade. Cuts in social welfare expenditure and public service production and higher taxes will be necessary for many years ahead to bring debt down to a level that will restore governments’ fiscal space. And should the need arise, governments’ capacity and appetite for intervening with new measures and rescue operations will probably have diminished in the meantime. 2  BIS Review 15/2010  Markets are now focusing on the four euro area countries Portugal, Ireland, Greece and Spain. Ireland may have broken the circle – by reducing nominal wages and showing the ability to cut government spending sharply. The other countries have not yet managed to regain the confidence of funding markets. The challenge they face is not only high deficits and substantial debt today, but also limited potential to grow out of their debt problems. The only remedy in that case is spending cuts. Icelandic banks were particularly vulnerable and their collapse had a severe impact on Iceland’s economy. The real economic environment in Iceland, with income levels now down to UK and Swedish levels, is conducive to growth. However, the problems left by the banks must be resolved before the economy can start to pick up. Third, in the US, the euro area countries and the UK, there is again almost double-digit unemployment.
With a few taps on the keyboard, people can make home equity withdrawals that are deposited in an online bank and are used to finance new purchases and current consumption. During a downturn bank earnings fall, losses rise and banks tighten lending. This can trigger several rounds of decline. This is the mechanism whereby fluctuations in the economy are amplified. The global banking crisis shows that credit cycles and property market bubbles that burst represent one of the greatest challenges to economic policy. They can build up over a long period. They are difficult to identify in real time and even after they burst there is doubt as to the causes. The fall in prices is abrupt and costly. It is particularly important to develop structures and mechanisms that better enable the economy to regulate itself. New equity capital and liquidity requirements for banks can promote financial stability. The requirements should probably be tighter in Norway than the minimum requirements that are likely to be agreed internationally. Norway’s economy is small, with concentrated risk for the banks. It is also important to cooperate with the other Nordic countries to avoid a situation where more lightly regulated banks aggressively market loans in Norway. Owing to flaws and major shortcomings, the tax treatment of capital and property in Norway amplifies credit cycles and house price fluctuations. The 1992 reform resulted in a tax system for Norway that is based on sound principles.