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Japan and U.S. on 'explosive' path: BoC

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The growing debt and deficits of both the United States and Japan are on potentially "explosive" paths, a governor at the Bank of Canada said in a speech on Tuesday.

Speaking in New York on the impact of the financial crisis and the steps taken in its wake to rebalance the global economy, Bank of Canada Deputy Governor John Murray warned that Japan and the United States must establish a plan to deal with their ballooning debt and constant deficits.

"Their debt and deficits are on explosive tracks and will only be made worse by demographic forces," he says.

But he also warned policymakers in countries implementing austerity policies to not go too far in their quest to balance their budgets.

"Fiscal consolidation, with one or two notable exceptions, is being pursued by many of the countries that require it. However, there is a risk that market forces (or legislation, as in the case of the United States) may be pushing it too quickly in the short run," he says. "The International Monetary Fund and other policy institutions are now recommending that consolidation be pursued in a resolute but gradual manner, where possible. In other words, don’t overdo it in the short run, since the fiscal multipliers are believed to be much larger than previously estimated."

Murray's remarks come as governments across Europe, most notably Greece, push through unpopular austerity budgets to lower their outstanding debt and eliminate deficits. In the U.S., the economy is headed for a self-imposed "fiscal cliff" that will eliminate more than $600 million US of spending – in the form of tax hikes and direct spending cuts -- from the economy.

Ratings agency Fitch Ratings recently warned the fiscal cliff could push the U.S. economy back into recession.

Murray also says the global economic recovery after the financial crisis has been "decidedly mixed," despite repeated attempts by central banks to spur growth by purchasing bonds and lowering interest rates.

"The deflationary forces in many countries appear to be winning," he says. "While global growth has not stalled completely, neither is it as strong or as widely distributed as many had hoped."

He says the "rebalancing" of the global economy that was supposed to occur after the financial crisis -- where developing countries would promote domestic consumption rather than exports -- has failed to occur.

"While some legitimate progress has been made in the rebalancing of global growth, most of the 'correction' that has occurred has been driven by demand compression in the deficit countries. The same is true for the rising share of domestic demand in many surplus countries," he says. "It is not a case of domestic demand growing significantly faster but, rather, declining export sales in the face of falling incomes and aggressive belt-tightening in deficit countries."

Murray says that in order for the global economy to get back on track the U.S. must deal with its fiscal cliff, Europe must come up with a comprehensive solution to its ongoing debt crisis and countries with budget surpluses must allow their exchange rates to be more flexible.

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