Sebastian Schmidt, 06 July 2021

Inflation shortfalls across the developed world have raised concerns about the possibility of low-inflation traps. This column presents a simple model of inflation to analyse the role of stabilisation policy in preventing them. It suggests that decisive countercyclical fiscal policy can protect economies from falling into a low-inflation trap by offsetting low inflation expectations. 

Davide Furceri, Prakash Loungani, Jonathan D. Ostry, Pietro Pizzuto, 03 June 2021

In the aftermath of past pandemics, fiscal policy played an important role in reducing or amplifying income inequality. This column predicts the likely distributional effects of Covid-19 by analysing evidence from five previous outbreaks (SARS, H1N1, MERS, Ebola, and Zika). It finds that severe austerity measures were associated with inequality increases three times greater than expansive fiscal policy following a pandemic. Premature austerity is self-defeating from both a macro and an equity standpoint.

Christian Bayer, Benjamin Born, Ralph Luetticke, 20 May 2021

Debt-financed fiscal expansions have been a critical feature in many countries’ policy response to Covid-19. This column revisits the role of public debt in stimulating economic recovery. The authors identify both short-run and long-run effects, highlighting that higher public debt has small effects on the capital stock but leads to a sizable decline of the liquidity premium, which increases the fiscal burden of debt. Further, the revenue-maximising level of public debt is positive and has increased to 60% of GDP post-2010.

Martin Larch, Janis Malzubris, Stefano Santacroce, 19 May 2021

In 2020, EU member states launched massive fiscal measures to mitigate the economic and social fallout of the Covid pandemic. The activation of the severe economic downturn clause of the Stability and Growth Pact, coupled with a decisive intervention of the ECB, offered member states the flexibility to stage their fiscal response. As this column reveals, however, a closer look through the lens of an expenditure benchmark highlights important cross-country differences reflecting deeper issues. Countries with very high debt and/or high sustainability risks are bound by their meagre growth prospects. If unaddressed, future reviews of the EU fiscal rules may buy time, but not solve the underlying issues. 

Michele Andreolli, Paolo Surico, 29 April 2021

What is the consumption response to unexpected transitory income gains of different size and what are the aggregate demand implications of stimulus packages that target different segments of the population? This column explores these questions using responses to hypothetical questions in the Italian Survey of Household Income and Wealth. Families with low cash-at-hand display a higher marginal propensity to consume out of small gains, while affluent households exhibit a higher marginal propensity to consume out of large gains. For a given level of public spending, a fiscal transfer of a smaller size paid to a larger group of low-income households stimulates aggregate consumption more than a larger transfer paid to a smaller group.

Olivier Blanchard, Álvaro Leandro, Jeromin Zettelmeyer, 22 April 2021

The EU’s fiscal rules are currently suspended. If reinstated, they will need to be modified to account for the higher levels of debt. This column, part of the Vox debate on euro area reform, argues that simple fiscal rules provide a crude and unsatisfactory assessment of debt sustainability and proposes that they be replaced with fiscal standards. In particular, it calls for qualitative prescriptions that leave room for judgement together with a process to decide whether the standards are met. This proposal envisages a larger surveillance role for independent fiscal councils and/or the European Commission, as well as a judicial body for adjudication over disputes. 

Vincent Aussilloux, Adam Baïz, Matthieu Garrigue, Philippe Martin, Dimitris Mavridis, 19 February 2021

The Covid-19 crisis has presented policymakers across the euro area with an unprecedented challenge, not least of all because the shock has come to both the supply side and the demand side of the economy. This column presents a preliminary analysis of different nations’ responses so far, focusing on which measures have been deployed to address each side of the economic shock and where a ‘mixed approach’ has been taken to work in tandem. At a time where coordinated action may be needed, there is a concerning level of inconsistency in strategy. 

Cristiana Belu Manescu, Elva Bova, 07 February 2021

Expenditure rules are recognised as one of the most effective tools to manage budgetary aggregates, and many EU members have recently chosen to add an expenditure rule to their national frameworks. In many cases, the 2012 introduction of the expenditure benchmark at the EU level was a major catalyst. Against this background, this column takes stock of the current design of national expenditure rules across EU member states and provides new evidence on their effectiveness in reducing the procyclicality bias of fiscal policy.

Thiess Buettner, Boryana Madzharova, 27 October 2020

Facing the economic consequences of the Covid-19 pandemic, governments all over the world are considering providing a fiscal stimulus. A potentially powerful instrument to do so is a broad-based consumption tax such as VAT. This column argues that changes in VAT may have some effect in stimulating spending on certain consumer durable goods such as household appliances. However, these effects may be heterogenous across different product types and the timing and perceived credibility of the announcements are also important factors for policymakers to consider.

Joshua Aizenman, Hiro Ito, 27 October 2020

The economic policies of the US in the post-COVID era will have important implications for the global economy. This column outlines two different exit strategies for the US from the COVID-related debt-overhang and analyses their implications for emerging markets and global stability. A strategy of continuing loose fiscal policies and accommodating monetary policies may spur short-term growth but would also increase the risks a deeper crisis in the future. Alternatively, the US could adopt a two-pronged approach of shifting fiscal priorities towards expenses with high social payoffs and then promoting fiscal adjustments aimed at a primary surplus and debt resilience. The post-WWII success story illustrates the feasibility of, and gains from, a two-pronged fiscal strategy.

Niels Thygesen, Roel Beetsma, Massimo Bordignon, Xavier Debrun, Mateusz Szczurek, Martin Larch, Matthias Busse, Mateja Gabrijelcic, Eloïse Orseau, Stefano Santacroce, 26 October 2020

This year’s annual report of the European Fiscal Board provides new evidence that the EU fiscal framework does not deliver the goods. This column argues that it should be reformed without delay. As forging consensus among EU member states takes time, the activation of the general escape clause until end-2021 offers a window of opportunity to build a simpler, leaner and more effective fiscal contract. The year 2019 illustrated once again how EU member states largely failed to build buffers in good times, those very buffers that would have been welcome in the face of the Covid-19 shock. In 2019, and despite sustained economic growth, the aggregate EU government deficit has increased for the first time since 2011 while cases of non-compliance with the preventive arm of the Stability and Growth Pact (SGP). Like other common shocks before, the pandemic has exposed three long-standing gaps in EMU’s architecture: (1) the lack of a genuine and permanent central fiscal capacity; (2) adverse incentives to maintain or scale up growth-enhancing government expenditure; (3) an intractable set of rules and benchmarks poorly tailored to country-specific debt reduction needs and capacities.

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The Centre for Economic Policy Research, the Graduate Institute, Geneva and the International Monetary Fund invite you to a joint seminar on:

Public Investment for the Recovery
IMF October 2020 Fiscal Monitor

Wednesday 21 October, 2020
08:30-09:30 ECT (Washington)
13:30-14:30 BST (London)
14:30-15:30 CEST (Geneva)

This chapter of the IMF October 2020 Fiscal Monitor argues that governments need to scale up public investment to ensure successful reopening, boost growth, and prepare economies for the future. Low interest rates make borrowing to invest desirable. Countries that cannot access finance will however need to prioritize spending and increase investment efficiency. The chapter explains how investment can be scaled up whilst preserving quality. Increasing investment by 1 percent of GDP in advanced and emerging economies could create 7 million jobs directly, and up to 33 million jobs indirectly. Investments in healthcare, housing, digitalization, and the environment would lay the foundations for a more resilient and inclusive economy.

Join Raphael Espinoza, Giancarlo Corsetti and Beatrice Weder di Mauro in this joint seminar on the IMF's latest Fiscal Monitor.

Register online

Jeffrey Clemens, Stan Veuger, 28 September 2020

The COVID-19 shock has significant negative consequences for the finances of US state and local governments, especially since they are bound by balanced-budget requirements. Estimates of (expected) revenue shortfalls are therefore an important input in the allocation of federal funds to offset the pandemic’s effects on state and local government revenues. This column uses Congressional Budget Office projections of consumption and personal income to forecast sales and income tax bases and revenue for all of the states. Based on May and July projections, it estimates a total shortfall of $106 billion and $105 billion, respectively.

Lars Calmfors, 28 September 2020

High employment is an important objective for all governments. This column makes the case for numerical employment targets, arguing that such targets can help balance fiscal objectives while also strengthening the incentives for reforms that raise structural employment. For the case of Sweden, the author recommends two targets: the actual employment rate for 20–68-year olds, and the actual annual hours worked per person in the population.

João Guerreiro, Sérgio Rebelo, Pedro Teles, 09 September 2020

Immigration policy has become a hot-button issue in both Europe and the US, with questions concerning optimal policy as well as the welfare state dominating discussions. This column revisits the idea of the immigration surplus, exploring a number of possible scenarios in terms of how policymakers should address the challenge. Correctly configuring fiscal policy so as to capture the benefits of both high- and low-skill immigrant (and native) workers is at the heart of optimal policy design and may help to address the swelling anti-immigrant sentiment that continues to exist in many countries today. 

Andrea Presbitero, Ursula Wiriadinata, 05 August 2020

As interest rate-growth differentials (r-g) have turned negative in many countries, now could be the time for governments to pursue fiscal expansions. However, the downside risks of such policies should not be disregarded. Using a large sample of economies, this column finds that high and increasing public debts, especially when denominated in foreign currencies, can lead to more volatile r-g dynamics. In particular, this is associated with higher probabilities of r-g reversals, tail risks, and an increased exposure to domestic and global shocks. Policymakers should take note of these risks when designing future fiscal expansions.

Henrique Basso, Omar Rachedi, 03 August 2020

Advanced and developing economies are experiencing a swift process of population ageing that will shape both long-run macroeconomic trends, such as economic growth, as well as short-term business cycle fluctuations. Although the implications of population ageing on countries’ fiscal capacity have been extensively analysed, this column argues that secular shifts in demographics can also influence the effectiveness of fiscal policy as a demand-management tool. Using a New Keynesian model with a lifecycle structure,  it shows that output fiscal multipliers are larger in younger economies.

Jose Maria Barrero, Nicholas Bloom, Steven Davis, 14 July 2020

One of the most urgent economic impacts of the Covid-19 crisis is on labour markets. Widespread job losses, drastic increases in unemployment benefit claims, and the rise of working from home have dominated the discussion during the pandemic so far. This column presents evidence from the US, arguing that the pandemic itself represents reallocation of labour within the economy. As different sectors and occupations are hit with variable severity, the authors argue that policymakers should be wary of this variation, responding with policies that will hold firm over time.

Yothin Jinjarak, Rashad Ahmed, Sameer Nair-Desai, Weining Xin, Joshua Aizenman, 06 July 2020

There is an importance relationship between prevailing market factors and the dynamics of the COVID-19 pandemic across the euro area. This column presents evidence to suggest that during the pandemic, adjustments in euro area credit default swap spreads diverge substantially from levels implied by theoretical models. Mortality outcomes and fiscal announcements account for a proportion of this divergence. Results also imply ‘COVID dominance’, whereby the widening spreads can lead to unconventional monetary policies that primarily aim to mitigate the short-run distress of the worst economic outcomes, temporarily pushing away concerns over fiscal risk.

Yuliya Kasperskaya, Ramon Xifré, 01 July 2020

In the aftermath of crises, the state of public finances typically regains prominence in policy agendas. This column advances the hypothesis that three properties of the budgetary setup – reliability of projections, openness to scrutiny, and transparency – facilitate the exercise of the ‘budgetary analytical capacities’ of the government, legislature, and the wider public. It constructs an index of such capacities from the OECD Survey on Budget Practices. For the period 2012-2016, a simple measure of fiscal discipline is correlated with the index and is not correlated with other standard political-economy variables that are generally used to explain fiscal discipline.

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