Fiscal uncertainty has, however, emerged as the clear and present danger facing the US economy. The partial deal in Congress earlier this month has prevented the economy from falling over the fiscal cliff. But three inter-related fiscal challenges remain. •  First, the deferred budget sequester or spending cuts that kick in from March this year. •  Second, the debt ceiling that needs to be raised, beyond just the next six months. •  Third, and most important, a medium-term deficit reduction deal. 4. As it is, the partial expiry of previous tax cuts and exemptions could already be causing a fiscal withdrawal of about 1–1½ percentage points of GDP. If Congress fails to reach an agreement, the automatic spending cuts could impose an additional drag of 0.4% of GDP. Europe: strengthening the fiscal union while fighting a crisis 5. Europe has fared less well. As of 2012, the Eurozone economies have recovered less than 60% of the output lost during the crisis. For the last two years, the Eurozone has been caught in a vicious cycle between weak sovereigns and weak banks. The crisis has exposed basic design flaws in the architecture of the European Monetary Union, chiefly the absence of a fiscal union. 6. The challenges facing European policymakers are not trivial. They have to put in place the structures and policies necessary to address the design flaws of the currency union, while at the same time fight a recurrent crisis of confidence in the financial markets.
Given the long lags in monetary policy, central banks must look forward now and prepare a strategy for a smooth transition back to normalcy. Asian economies: dealing with desynchronised global macroeconomic cycles 31. The second key aspect in securing a return to normalcy is the adjustment of macroeconomic policies in the emerging market economies to spillovers from the advanced world. I will speak with reference to Emerging Asia. Continually shifting gears in monetary and fiscal policies 32. In the early stages of the financial crisis, most Asian countries responded with expansionary macroeconomic policies to dampen the effects of a collapse in exports. Between August 2008 and August 2009, policy rates across Asia were more than halved, on average. Substantial fiscal stimulus was injected, ranging from higher investment spending in China to significant tax cuts in Indonesia. Fiscal deficits across Asia widened from an average of 0.6% of GDP in 2008 to 3.0% in 2009. 33. From 2010 onwards, a two-speed recovery took hold in the global economy, with advanced economies growing sluggishly and Emerging Asia staging a vigorous rebound. Incipient inflationary pressures prompted central banks in the region to raise policy rates from mid–2010 onwards. Although renewed risks stemming from the Eurozone crisis led to a fresh round of easing in some economies in late–2011, policy rates in Emerging Asia are on average 75 basis points higher now vis-à-vis their troughs during the crisis. 4  BIS central bankers’ speeches  34. Fiscal stimulus has also been withdrawn progressively.