A Fine Balancing Act
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- Authors: VITOR GASPAR
- Published: March 1, 2022
Shift in fiscal role
- Before the global financial crisis of 2008, fiscal policy’s primary role was to avoid becoming a source of instability and to ensure long-term sustainable and inclusive growth; monetary policy with its focus on price stability was seen as delivering optimal output and employment.
- Fiscal institutions, rules, and procedures that kept spending and taxing in sync were considered key to sound public finances; fiscal policy’s main role was allocation and distribution of resources rather than stabilization.
- In 2020, fiscal policy assumed a crucial role in macroeconomic stabilization as prices and demand plummeted and central banks were constrained by interest rates that could go no lower.
Pandemic fiscal response and consequences
- Fiscal actions in 2020 were implemented decisively and rapidly, involving massive increases in spending that led to large budget deficits and unprecedented levels of government debt.
- Historically high levels of public debt coincided with historically low interest rates and, for advanced economies, low interest cost of servicing public debt; with inflation and interest rates rising, the question is how, and how fast, deficits and debt levels will be reduced.
- There is concern that burden of deficit- and debt-reduction policies (spending cuts and tax increases) will fall predominantly on people already hardest hit by the pandemic—such as caregivers, low-wage earners, and less-qualified workers.
- There is also concern that premature austerity could jeopardize economic recovery.
Distributional impacts and poverty
- United States example:
- US poverty fell in 2020 according to the Supplemental Poverty Measure rate: 9.1 percent of the population in 2020, 2.6 percentage points lower than in 2019.
- The official poverty rate increased 1.0 percentage point to 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 2020.
- Other countries, such as Brazil, also experienced falls in poverty in 2020.
- Statement: "Poverty and inequality are fundamentally influenced by political choices."
Monetary–fiscal interaction when interest rates are constrained
- Estimates of the neutral real interest rate have been declining significantly in recent decades in the United States, the euro area, and Japan, implying the effective lower bound will increasingly constrain central banks.
- In 2020 interest rates fell to near zero but could not revive an economy in free fall; monetary policy used unorthodox techniques such as forward guidance and asset purchases.
- Even as monetary policy’s ability to influence the economy was constrained, fiscal policy space increased; governments cut taxes and directed resources to households and businesses to offset pandemic effects, stabilizing expectations and supporting monetary policy’s aim of delivering price stability.
- Quotation preserved: John Maynard Keynes in 1923: “what Government spends the public pays for. There is no such a thing as an uncovered deficit.”
- Fiscal actions are most powerful when they are needed the most.
Global debt, growth outlook, and implications for development goals
- 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 pose major concerns for the eradication of poverty and for attainment of the Sustainable Development Goals (SDGs) agreed to by 190 countries in 2015; those 17 goals aim to result in a world in which extreme poverty is eliminated and opportunities and capacities expand for all.
- 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.
Policy implications and IMF role
- Budgetary adjustment is unavoidable when financing is scarce and must be compatible with available financing, which is typically scarcest when and where it is most needed.
- An important IMF activity, enshrined in its Articles of Agreement, is to make resources available to member countries to facilitate their ability to correct imbalances—such as a sudden stop in external financing, unsustainable public finances, or a banking crisis—without resorting to drastic 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.
VITOR GASPAR, A Fine Balancing Act, March 2022, F&D Magazine
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