Fiscal Policy Can Help People Rebound From Cost of Living Crisis

IMF Blog, October 12, 2022

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Governments face difficult trade-offs amid sharp increases in food and energy prices: protect low-income families from large real income losses and ensure access to food and energy, while reducing vulnerabilities from large public debts and maintaining a tight fiscal stance to avoid working at cross-purposes with monetary policy.
Food prices have been up by half since 2019 and supply disruptions have persisted in both food and energy markets.
Most governments face further pressure on public finances already strained by the pandemic: rising inflation, weakening currencies, and climbing interest rates have led to surging credit spreads in many countries and higher interest expense going forward.
Global public debt is projected to remain elevated at 91 percent of GDP in 2022—after receding from a historic high in 2020—and remains about 7.5 percentage points higher than pre-pandemic levels.
Low-income countries are particularly vulnerable: nearly 60 percent of the poorest economies are in debt distress or at high risk of it.

Policymakers should prioritize targeted support through social safety nets to the most vulnerable people given high debt levels and rising borrowing costs.
Possible measures include providing discounts on utility bills (for basic usage) to vulnerable low- and middle-income families.
Allowing energy prices to adjust is crucial to preserving incentives to curb energy use and increase supply.
Governments should avoid attempting to limit price increases through price controls, subsidies, or tax cuts when faced with long-lasting supply shocks and broad-based inflation because such measures would be costly to budgets and ultimately ineffective.
Many low-income countries will need greater global efforts in humanitarian assistance and emergency financing due to limited domestic resources.
In a time of high inflation, policies to address high food and energy prices should not add to aggregate demand; demand pressures force central banks to raise interest rates even higher, making it more expensive to service government debt.
A tightening fiscal stance sends a powerful signal that policymakers are aligned in their fight against inflation.

Governments need to build resilience over time to a range of adverse shocks—pandemic, global financial crisis, natural disasters, and other adverse events—by preparing for rainy days and building fiscal buffers gradually to allow swift and flexible crisis responses.
Several fiscal tools used during the pandemic can become part of a more permanent toolkit, depending on countries’ capacity and available fiscal space:
- Job-retention schemes stabilized more than 40 percent of individual income loss in the European Union.
- Exceptional financial support to companies can prevent widespread bankruptcies but should be reserved for severe crises because it exposes governments to sizable fiscal risks.
Social safety nets help people bounce back from unemployment, sickness, or poverty and can be made readily scalable and better targeted with digital technology.
Countries should rethink the role of fiscal policy in a shock-prone era—how it can better buffer against losses during crises and build resilience—and learn from experiences across the world.

Median fiscal cost of measures introduced to address higher food and energy prices estimated at 0.6 percent of national gross domestic product, on top of pre-existing subsidies, among countries for which estimates were available.
Food prices have been up by half since 2019.
Global public debt projected at 91 percent of GDP in 2022.
Public debt remains about 7.5 percentage points higher than pre-pandemic levels.
Nearly 60 percent of the poorest economies are in debt distress or at high risk of it.
Job-retention schemes stabilized more than 40 percent of individual income loss in the European Union.

This blog is based on the October 2022 Fiscal Monitor, “Helping People Bounce Back.”