## EXECUTIVE SUMMARY ## Source details **Canonical URL:** [EXECUTIVE SUMMARY](https://www.imf.org/-/media/files/publications/fiscal-monitor/2023/april/english/execsum.pdf) ## Other formats - [Markdown version](/-/media/files/publications/fiscal-monitor/2023/april/english/execsum.pdf.md) - [Structured JSON version](/-/media/files/publications/fiscal-monitor/2023/april/english/execsum.pdf.json) --- ### Chapter 1: On the Path to Policy Normalization - Context and recent developments - Three years since the outbreak of the COVID-19 pandemic, fiscal policy is returning to normal. - After providing extraordinary support simultaneously in 2020, both monetary and fiscal policy tightened in nearly three-quarters of countries in 2022 amid high inflation and the expiration of pandemic-related spending measures. - The shift to normalization occurred in a highly volatile environment including a cost-of-living crisis, Russia’s invasion of Ukraine, and instability in the financial sector. - The global economy has recovered swiftly, and the economic and social fabric has thus far withstood disruptions to energy supply. However, multiple shocks have reversed gains in poverty reduction and likely push eradication of extreme poverty by 2030 farther into the future. - Food prices in domestic currencies remain high in several countries, owing in part to exchange rate depreciations. - Long-standing challenges—including the climate agenda and population aging—have become more pressing. - Public finances and recent swings - Public debt surged to nearly 100 percent of GDP in 2020 as a result of economic contraction and massive government support. - With strong nominal GDP growth in 2021–22, global debt posted the steepest decline in 70 years and stood at about 92 percent of GDP at the end of 2022, still about 8 percentage points above the level at the end of 2019. - Primary deficits are falling rapidly and moving closer to prepandemic levels in many countries, but overall deficits have fallen somewhat less owing to rising interest payments. - In 2022, most countries experienced revenue surprises amounting to 3.1 percent of GDP on average for advanced economies and 2.5 percent for emerging market and developing economies, with particularly large revenue windfalls in oil exporters. - Many countries saved part of the extra revenues; many others increased spending to counter the cost-of-living crisis. - In some cases, particularly countries with large initial debt stocks in domestic currency, debt ratios fell by more than 10 percentage points in a year as nominal GDP surged. - Debt dynamics deteriorated in emerging market economies and low-income developing countries with sizable shares of debt in foreign currency, as currency depreciation and rising interest rates came together with inflation. - Near-term fiscal outlook and risks - In 2023, overall fiscal deficits are expected to increase slightly to 5 percent of GDP on average, as governments face higher interest bills and pressures to increase public spending, including spending on wages and pensions, to catch up with past inflation. - Risks are firmly to the downside (see the April 2023 World Economic Outlook and Global Financial Stability Report). - Instability in the financial sector, if it intensifies, could put pressure on public sector balance sheets as governments may be called to help. - Fiscal and monetary policies need to be closely aligned to deliver price and financial stability while responding to an uncertain economic environment and rapidly changing financial conditions. - If inflation proves to be stickier than expected, it will require tighter policies for longer. - In a scenario of systemic financial stress, fiscal policy may need to intervene swiftly to facilitate the resolution process and minimize its costs, while mitigating moral hazard. Governance principles, supported by strong insolvency and bankruptcy procedures, should be applied in the decision-making process to safeguard public funds. - Given downside risks, fiscal and monetary policies should stand ready to respond if economic growth turns out significantly weaker than expected and unemployment rises. Governments should allow automatic stabilizers to work, especially where inflation is under control and fiscal space is available. - Medium-term outlook and structural concerns - Over the medium term, fiscal deficits are projected to remain above prepandemic levels in the next few years. - Under current projections, the envisaged gradual and moderate fiscal tightening will not be sufficient to prevent public debt ratios from resuming an upward trend as nominal GDP slows, driven by some large advanced and emerging market economies. - Interest payments as a share of revenues in emerging market economies and low-income developing countries are expected to remain higher over the medium term than before the pandemic. - In low-income developing countries, concerns persist regarding heightened debt vulnerabilities because of high debt levels, with 39 countries already in or near debt distress. - Despite multiple waves of tax reforms in these countries, revenues remain stubbornly insufficient at 13.5 percentage points of GDP lower than revenues in advanced economies. This calls for renewed efforts to raise tax capacity. - Policy implications and international cooperation - Recent crises have taught that fiscal policy is a powerful tool to foster resilience; governments need to prioritize rebuilding fiscal buffers. - Countries should develop credible risk-based fiscal frameworks that promote consistent macroeconomic policies, reduce debt vulnerabilities over time, and build up the necessary room to handle future shocks. - The international community needs to work together to find joint solutions to the multiple challenges ahead. - For the most vulnerable economies, it is urgent to strengthen the international financial architecture, especially in debt resolution and enhancement of the Global Financial Safety Net. - Many low-income countries need further international efforts to address sovereign debt vulnerabilities, including debt relief, so that they can make progress toward the Sustainable Development Goals. - The recent energy crisis has demonstrated the urgency of pressing ahead with the transition to renewable energy to safeguard energy security and mitigate climate change. International cooperation on energy strategy, including carbon taxes and subsidies, would help achieve climate goals and avoid trade tensions. ### Chapter 2: Inflation and Disinflation: What Role for Fiscal Policy? - Inflation context and distributional concerns - The upsurge in inflation since 2021—the sharpest in more than three decades—has called on policymakers to respond. - Government policies need to be informed by an understanding of how inflation affects various groups in society through uneven impacts on the budgets of different households. - Governments influence distribution of inflation’s costs not only through discretionary intervention but also through automatic indexation of pensions, transfers via social safety nets, wages of civil servants, and tax thresholds. - A survey shows indexation varies considerably across countries: pensions are the most commonly indexed—in nearly all advanced economies and about 40 percent of emerging market and developing economies—followed by cash transfers to vulnerable groups and public wages. - Immediate fiscal impacts of inflation (infographic highlights) - Nominal GDP increases with inflation lead to lower fiscal deficits and public debt as a ratio to GDP. - The nominal tax base grows with inflation (for example, value-added tax and profit tax). - If income tax brackets are not indexed to inflation, taxpayers may be pushed into higher tax brackets (bracket creep). - Primary expenditure does not usually move immediately with inflation, but public expenditure can increase with a short delay via indexation of public goods and services (for example, public wage, social benefits, subsidies, pension, and medical expenses). - Interest payments on inflation-indexed bonds go up with inflation. - Governments with more short-term debt (S) than long-term debt (L) face higher refinancing costs as investors ask for higher returns to compensate for expected inflation. They pay higher interest on foreign-currency-denominated debt (F) than on domestic-currency debt (D) when the currency depreciates due to inflation. - Quantitative effects on public debt and deficits - For countries with debt exceeding 50 percent of GDP, each 1 percentage point surprise increase in inflation is estimated to reduce public debt by 0.6 percentage point of GDP, with the effect lasting over the medium term. - These effects are smaller or negligible for countries with a large share of debt denominated in foreign currency. - When inflation is expected, it is not associated with a decline in debt ratios. - Deficit-to-GDP ratios initially decline as nominal values of output and the tax base rise, but such effects dissipate over time. - Distributional effects on households and poverty - Analysis using household surveys from Colombia, Finland, France, Kenya, Mexico, and Senegal estimates the price acceleration from Q2 2021 to Q2 2022 through three channels: (1) real incomes (wages and pensions), (2) losses in net nominal assets, and (3) faster-than-average price rises for main goods and services consumed by a group (such as food). - Results show changes in real income were the most important channel and differed the most across countries but less so across income groups. - Losses on net nominal assets were larger for older groups than for young adults in countries with sizable household credit markets. - During the period considered, the estimated impact of inflation on the poverty rate (prior to new policy measures in response) is about 1 percentage point in three countries in the sample (France, Mexico, Senegal). - Fiscal policy’s effect on inflation and interaction with monetary policy - Estimates indicate that an increase in public spending of 1 percentage point of GDP led to an increase in inflation of 0.8 percentage point in the 1950–85 period and of 0.5 percentage point thereafter. - The post-1985 difference arguably stems from a more forceful response by central banks to rising inflationary pressure. - A model embedding inequality in incomes, consumption, and asset holdings shows that a reduction in the fiscal deficit leads to a similar level of disinflation but requires a smaller increase in interest rates than when central banks act alone. - Deficit reduction combined with transfers to the poorest yields a smaller drop in total private consumption and a consumption path associated with less inequality across households. - These effects are even more important when public debt is high because fiscal restraint limits the rise in the cost of borrowing and reduces debt vulnerabilities. - Lessons and policy guidance - Although surprise inflation may occasionally offer some breathing room for debt ratios, attempts to keep surprising bondholders have historically proved futile or harmful. - When reviewing automatic or discretionary indexation, policymakers need to decide which programs and groups to protect from income erosion while avoiding excessive indexation or other policies that make inflation more persistent. The impact of decisions about public wages (including choices regarding indexation) on private wage setting should be carefully assessed. - When considering new measures or reforms against the backdrop of significant inflation, policymakers should consider that different groups of households may already be experiencing sizable distributive effects. - Fiscal policy—involving tough policy choices on what budget items to cut and which to protect or expand—can support monetary policy in bringing down inflation while protecting those most affected by the cost-of-living crisis. *International Monetary Fund | April 2023* --- _Source: https://www.imf.org/-/media/files/publications/fiscal-monitor/2023/april/english/execsum.pdf_