Fiscal Policies for a Transformed World

IMF Blog, July 10, 2020

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Fiscal Policies for a Transformed World

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• Authors: Vitor Gaspar, Gita Gopinath
• Published: July 10, 2020

Immediate fiscal response and current risks

• The ongoing COVID-19 pandemic has already prompted an unprecedented fiscal policy response of close to $11 trillion worldwide.
• Global public debt has reached its highest level in recorded history, at over 100 percent of global GDP, in excess of post-World War II peaks.
• According to the Fiscal Monitor database of country fiscal measures in response to the COVID-19 pandemic, covering a representative sample of over 50 countries, total global fiscal support so far has been split almost evenly between above-the-line – measures with a direct effect on revenue and expenditure such as deferral of taxes and cash transfers – and below-the-line support, which includes public sector loans, equity injections and government guarantees.
• Top priority: public health. Policies that attenuate health risks contribute substantially to the restoration of confidence and trust, helping economic activity and employment and reducing strains on public finances.
• Accurate, timely and comprehensive data on health and socio-economic outcomes are essential to monitor outbreaks and react swiftly to them.

Fiscal policy during reopening and transition

• Fiscal policy will need to remain supportive and flexible until a safe and durable exit from the crisis is secured.
• An earlier-than-warranted fiscal retrenchment presents an even greater risk of derailing the recovery, with larger future fiscal costs.
• Policymakers should prepare contingent plans that can be flexibly scaled to manage the health, economic and fiscal risks from recurrent outbreaks.
• To prevent lags in delivery of targeted support, a new generation of automatic stabilizers may be needed.
• The crisis is transformational: many jobs destroyed by the crisis will likely not return. Support should shift from maintaining jobs to supporting people as they retrain or relocate across sectors.
• Governments should distinguish illiquid but solvent firms from insolvent ones; possible measures include using convertible bonds and injecting equity into (or even temporarily nationalizing) strategic and systemic firms.
• Swift actions are needed to improve legal mechanisms for resolving debt overhang and preventing long-run economic scarring.

Keeping debt levels sustainable — projections and caveats

• In 2020, relative to the January 2020 World Economic Outlook, fiscal deficits are expected to be more than five times higher in advanced economies (AEs) and to more than double in emerging market economies (EMEs), leading to an unprecedented jump in public debt of respectively 26 and 7 percentage points of GDP.
• Many governments will benefit from borrowing costs that are at historical lows and projected to stay that way for a long time as the crisis raises precautionary savings and dampens investment demand.
• With economies projected to function below potential for a while, inflationary pressures will remain muted and so will the need for central banks to raise interest rates.
• Public debt is expected to stabilize in 2021 (excluding the United States and China), spurred by low interest rates and a projected strong rebound in economic activity in the baseline.
• Caution: there is great diversity in debt levels and financing abilities across countries and high uncertainty surrounding the forecasts. Borrowing costs can increase rapidly, particularly for emerging economies and frontier markets, as was the case in March.
• Governments will need to pursue a credible medium-term fiscal plan that relies on:
  • improving revenue mobilization – including through minimizing tax avoidance, greater tax progressivity in some cases, carbon pricing and higher efficiency in spending (for example, eliminating fossil fuel subsidies);
  • transparent communication of any plan to help contain potential volatility in sovereign debt markets in the transition.
• International institutions must ensure that access to international liquidity is not disrupted by self-fulfilling market panics.
• The international community must ensure that vulnerable low-income developing countries (LIDCs) have access to concessional financing and, in some cases, grants.
  • Seventy-two countries have already received IMF emergency assistance, but far more bilateral and multilateral support will be needed.
  • Poorer nations may need continued debt relief, including through the G20 Debt Service Suspension Initiative.

Fiscal policies post-COVID-19 — priorities for recovery and resilience

• Once effective vaccine and therapeutics against COVID-19 are widely available, governments should redirect fiscal policy toward resilient, sustainable and inclusive growth.
• Policymakers should tackle the rising poverty and inequality, as well as the structural weaknesses exposed by the crisis, to better prepare for future shocks.
• Priority investments and policy directions:
  • stronger health systems;
  • better resourced social safety nets;
  • digitalization;
  • climate-friendly investments that promote greener, job-rich and innovation-driven growth.
• Fiscal policy must tackle inequality through spending aimed at universal access to health and education and progressive tax systems.
• Flexibility is essential: whatever the post-COVID-19 world looks like, it will require flexible fiscal policies that facilitate structural change, address inequality and support the transition to a greener future.

Source: Fiscal Policies for a Transformed World — Vitor Gaspar, Gita Gopinath, July 10, 2020.