Without structural reforms to enhance competitiveness, the debt-ridden countries in southern Europe are likely to require repeated and increasingly large rescue packages. And, without structural reforms in Japan and the United States, they will continue their loose monetary policies to keep interest rates low in order to support the financial system, help indebted households, and reduce the cost of public debt. The likely outcome is that the Eurozone, Japan, and the United States will all be trapped in a protracted “new normal” of slow growth, high risks, and low returns on financial investment. Low interest rates will also encourage short-term speculative capital flows to international commodity markets (resulting in volatile prices) and to emerging economies (resulting in asset bubbles, currency appreciation, and difficulties in macroeconomic management).

The problem is that structural reform is contractionary and may cut more deeply into jobs, economic growth, and government revenues, at least in the short run. Thus structural reforms are not politically feasible in many countries. And, even if implemented, such reforms might not reduce the fiscal deficit, because social spending generally increases in response to rising unemployment and fiscal revenue shrinks when growth slows. The market will respond negatively to the rising public debt.

The standard recommendation has long been to offset the contractionary effects of structural reforms by devaluing the currency to increase demand for a country’s exports. But any attempt at currency devaluation in the Eurozone, Japan, or the United States could trigger a currency war and competitive devaluations. Instead, high-income countries need to stimulate demand to create space for structural reforms. Public or private debt restructuring and fiscal consolidation should not be the priority.