Making Economies More Resilient to Downturns
IMF Blog, May 18, 2020
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Bibliographic details
- Authors: John Bluedorn, Wenjie Chen
- Published: May 18, 2020
Overview
- Publication date: May 18, 2020
- Authors: John Bluedorn, Wenjie Chen
- Context: The COVID-19 pandemic and the ensuing Great Lockdown have pushed many countries into deep recessions—worse than during the 2008–09 global financial crisis.
- Central observation: With interest rates at record lows and public debts at historical highs in many countries, advanced economies need to prepare for future downturns by strengthening fiscal-policy resilience, notably through rules-based fiscal stimulus measures.
Rationale for rules-based fiscal stimulus
- Conventional monetary policy scope is limited when interest rates are at or near zero; central banks may use unconventional tools, but relying on monetary policy alone can raise concerns about financial stability and central bank independence.
- Rules-based fiscal stimulus is defined as fiscal measures that are automatically triggered by deteriorating macroeconomic indicators (for example, when the unemployment rate rises above a certain threshold), distinct from traditional automatic stabilizers that respond to individual circumstances.
- Well-communicated, pre-established rules can shape expectations, reduce uncertainty, and dampen activity declines when negative shocks occur.
Key findings from the analysis
- Rules-based fiscal stimulus measures—such as temporary targeted cash transfers to liquidity-constrained, low-income households that kick in when the unemployment rate rises above a certain threshold—could be highly effective in countering a downturn caused by a typical demand shortfall.
- Rules-based fiscal stimulus is particularly effective when:
- interest rates are at their effective lower bound;
- discretionary fiscal policy lags are long;
- the economy has unemployed resources; and
- monetary policy is accommodative.
- When demand falls suddenly, the fall in output and rise in debt ratios are smaller when rules-based fiscal stimulus is in place.
- Economic downturns with rules-based fiscal stimulus in place can be countered nearly as effectively as when monetary policy is able to operate at full strength.
- The current pandemic shock is unusual because it affects both supply and demand; when workers and firms cannot operate while the epidemic is active, fiscal multipliers are low, reducing the immediate effectiveness of stimulus to boost output.
- Even in the pandemic context, pre-implemented rules-based targeted transfers could provide income insurance and strengthen the social safety net for the vulnerable.
Policy recommendations
- Enhance fiscal policy’s automatic response to negative shocks by designing and adopting rules-based fiscal stimulus measures.
- Improve existing automatic stabilizers to bolster resilience to downturns.
- Ensure rules for fiscal stimulus are well communicated and established before shocks occur to help shape expectations and reduce uncertainty.
- Use monetary policy to support fiscal stimulus in recessions by maintaining an accommodative stance, including by easing financial market conditions, even if interest rates cannot be cut further.
- Continue to employ discretionary fiscal measures tailored to the specific circumstances and nature of shocks (for example, the pandemic), recognizing that discretionary measures remain essential and must be adopted and deployed in a timely manner.
Implementation considerations and trade-offs
- Designing and adopting new fiscal tools and improving automatic stabilizers will take time and require political agreement.
- Automatic policies for fiscal stimulus reduce the risk that political hurdles delay responses when economic conditions deteriorate.
- Rules-based fiscal stimulus can markedly reduce the likelihood of demand-driven recessions when monetary policy is constrained, but it does not render discretionary fiscal policy redundant.
- Timing matters: because historical discretionary fiscal stimulus implementation has often been delayed, rules-based automatic triggers provide a more timely countercyclical response.
Based on Chapter 2 of the World Economic Outlook, “Countering Future Recessions in Advanced Economies: Cyclical Policies in an Era of Low Rates and High Debt,” by Michal Andrle, Philip Barrett, John Bluedorn (co-lead), Francesca Caselli, and Wenjie Chen (co-lead).
