The worst of the recession now thankfully appears to be behind us. Financial conditions worldwide have improved. Risk premia in money and credit markets have dropped to precrisis levels and equity markets have registered strong gains. Although at a slow pace, growth has resumed, boosted by the strong performance of Asian economies and a degree of stabilization in industrialized countries. The euro area economy, too, has been improving, and finally emerged from recession in the third quarter on the back of stronger external demand. A word of caution is warranted, however, because the experience of recessions that followed financial crises suggests that the recovery will only be gradual. Both the IMF and the European Commission expect the world economy to expand by only about 3 per cent next year, compared with an average of 5 per cent in 2004-2007. 1 This expansion, moreover, is expected to be led by emerging economies, especially in Asia, because growth in the industrialised economies is forecast to average below 2 per cent. The recovery in the euro area is similarly expected to be modest. The Commission forecasts growth rates of 0.7 per cent in 2010 and 1.5 per cent in 2011. Foreign demand is seen as the main engine of growth, while the required de-leveraging of balance sheets in the financial sector, along with excess capacity and unemployment heading for double digit levels will continue to weigh on domestic demand.
For a start, each year’s deficit translates into higher debt and debt-servicing burdens, which already stand at 67 per cent and 3.4 per cent of GDP, respectively. 5 Put differently, the 196 million euro in interest due on the debt next year is equivalent to what the Government would spend on medicines  2  Structural Issues Report 2010, which focuses on the impact of the energy markets on the macroeconomy. A detailed report is to be published next year in the form of an ECB Occasional Paper. 3  Weathering the challenges, in Ernst & Young’s 2009 Malta Attractiveness Survey. 4  Paul Krugman, The Age of Diminished Expectations: US Economic Policy in the 1980s, MIT Press, 1992  5  Estimates taken from the Budget speech 2010. 4  BIS Review 154/2009  in three years at today’s prices. To complete this perspective, despite the reduction planned from 2011, the general government deficit in that year is still expected to remain just above the 3 per cent benchmark, and the forecast reduction to 2.9 per cent in 2012 is contingent on seemingly optimistic nominal growth assumptions. What are the options for reducing the deficit? Since any increase in the tax burden, already high at around 40 per cent of GDP, would have a negative impact on competitiveness, expenditure restraint seems to be the only possibility. This option is more complex than it might seem, however, because of the structure of recurrent government spending.