## A FINE BALANCING ACT

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### The evolving role of fiscal policy
- Before the global financial crisis of 2008, fiscal policy’s main role was to avoid becoming a source of instability and to support long-term sustainable and inclusive growth rather than to stabilize output and employment.
- Fiscal institutions, rules, and procedures were viewed as key to keeping spending and taxing in sync.
- The pandemic reversed this consensus: in 2020 fiscal policy took on a crucial role in macroeconomic stabilization when monetary policy was constrained by low interest rates.

### Pandemic response and immediate outcomes
- In 2020, governments implemented decisive and rapid fiscal actions—cutting taxes and directing resources to households and businesses—to offset lockdowns, massive job losses, and demand declines.
- Massive increases in spending led to large budget deficits and unprecedented levels of government debt, coinciding with historically low interest rates and, for advanced economies, low interest cost of servicing public debt.
- The United States example:
  - US Supplemental Poverty Measure rate in 2020: 9.1 percent of the population.
  - This was 2.6 percentage points lower than in 2019.
  - Official poverty rate in 2020: 11.4 percent (an increase of 3.3 million people).
  - The expansion of the US social safety net (support checks and increased unemployment benefits) more than compensated for wages and jobs lost during the first year of the pandemic.
- Poverty also fell in 2020 in other countries, such as Brazil.
- Fiscal policy became instrumental in stabilizing expectations and supporting monetary policy’s aim of delivering price stability in a timely way.

### Interaction with monetary policy and interest rate constraints
- In the United States, the euro area, and Japan, estimates of the neutral real interest rate have been declining significantly in recent decades, increasing the likelihood that the effective lower bound will constrain central banks.
- In 2020 interest rates fell to near zero, limiting monetary policy’s ability to revive economies in free fall and prompting greater use of unorthodox techniques (forward guidance and asset purchases).
- When monetary policy is constrained, fiscal policy space increased and proved highly effective.

### Distributional risks and timing of consolidation
- With inflation and interest rates rising, the policy challenge is how, and how fast, deficits and debt levels will be reduced.
- There is concern that deficit- and debt-reduction measures (spending cuts and tax increases) will disproportionately affect those hit hardest by the pandemic—caregivers, low-wage earners, and less-qualified workers.
- Premature austerity could jeopardize economic recovery.

### Global debt accumulation and divergent recoveries
- During 2020, advanced economies and China contributed more than 90 percent to the accumulation of public and nonfinancial private debt.
- The remaining countries accounted for only about 7 percent.
- Advanced economies and China are projected to return to the pre-COVID growth path over the next one to three years.
- Developing economies are expected to fall below the growth prospects projected before the pandemic because they were severely constrained in their ability to respond.
- Reduced growth prospects and persistent declines in tax revenues threaten poverty eradication and attainment of the Sustainable Development Goals (SDGs).

### Financing the SDGs and the IMF’s role
- Financing and revenue mobilization are key enablers of the SDGs.
- The international community provided critical support in 2020 and 2021, but more is urgently needed.
- The IMF’s Articles of Agreement commit it to make resources available to member countries to facilitate correction of imbalances (sudden stops in external financing, unsustainable public finances, or banking crises) without resorting to measures that destroy national and international prosperity.
- Availability of IMF resources is meant to build confidence during crises when countries have lost, or are at risk of losing, their ability to borrow in open markets; nonetheless, budgetary adjustment remains unavoidable and must be compatible with available financing.

*VITOR GASPAR is director of the IMF’s Fiscal Affairs Department.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2022/march/gaspar.pdf_