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'Great Crisis' To Reshape Future Fiscal Policy: IMF

Wednesday, February 17, 2010

The International Monetary Fund (IMF) has entered into the debate about how macroeconomic policy – particularly fiscal policy - should be adjusted, drawing lessons from the worst global recession in 60 years.

In an interview to mark the publication of the IMF paper "Rethinking Macroeconomic Policy," chief economist at the IMF, Olivier Blanchard, said in an interview with Jeremy Clift for IMF Survey Magazine: “As the crisis slowly recedes, it’s time for a reassessment of what we know about how to conduct macroeconomic policy. Our goal in this piece is to lay out some key questions about the design of macroeconomic policy frameworks, and to develop some ideas on how those frameworks might be strengthened.”

“The crisis has returned fiscal policy to center stage as a macroeconomic tool, for two main reasons: first, to the extent that monetary policy, including credit and quantitative easing, had largely reached its limits, policymakers had little choice but to rely on fiscal policy; second, from its early stages, the recession was expected to be long lasting, so that it was clear that fiscal stimulus would have ample time to yield a beneficial impact despite implementation lags.”

Blanchard indicated that a relaxed attitude amongst advanced economies with regard to "fiscal space" meant that when the global financial crisis hit, those countries' governments were afforded limited room to maneuver fiscal policies to boost their economies. “Some advanced economies that entered the crisis with high levels of debt and large unfunded liabilities have had limited ability to use fiscal policy, and are now facing difficult adjustments.”

He further observed that “emerging market economies (some, for example, in Eastern Europe) that ran highly procyclical fiscal policies, driven by consumption booms, are now being forced to cut spending and increase taxes despite unprecedented recessions. By contrast, many other emerging markets entered the crisis with lower levels of debt, this allowed them to use fiscal policy more aggressively without fiscal sustainability being called into question or ensuing sudden stops.”

“This suggests that we should revisit target debt to GDP ratios. Maybe we should aim for much lower ratios than before the crisis. This is a long way off, given where we start, but this is another issue we must revisit.”

Turning to address tax policy that could be implemented immediately to respond to future economic crises, Blanchard added: “Discretionary fiscal policy measures usually come too late to fight the downturn because it takes time to put in place tax cuts or new spending measures. There is, therefore, a strong case for improving what are called the fiscal stabilizers."

“For example, one could think of temporary tax policies targeted at low-income households, investment credits, or temporary social transfers that would be triggered by a macroeconomic variable crossing some threshold (the unemployment rate, say, rising above 8%)," Blanchard explained.

"Our paper argues that we need to look carefully at measures that would automatically kick-in during a downturn and have a significant impact on the economy.”