That was the week we saw the austerity funeral. Those who used to worship at his altar now urge countries to exercise caution. The fiscal orthodoxy practiced for decades since the debt crises and inflation of the 1970s and 1980s has been replaced by fiscal activism.
As the annual IMF and World Bank meetings in Washington DC close this weekend in virtual form, many of the leaders at the top – and in the research departments – of these institutions sang a new tune on fiscal policy this week.
Carmen Reinhart, the eminent economic historian who is now the World Bank's chief economist, recommended that countries take out large loans during the pandemic. "While the disease rages, what else are you going to do?" She asks. "First you worry about the war, then you figure out how to pay for it."
Ms. Reinhart was one of the leading proponents of austerity a decade ago after she published a research paper that found that at a similar point in time in the 2008-09 financial crisis – where we are now – high government debt was undermining economic performance. It concluded that "traditional debt management issues should be at the fore in public policy issues".
Carmen Reinhart, who was pictured at the World Economic Forum in 2011, was one of the leading proponents of austerity measures after the 2008-09 financial crisis. © Tomohiro Ohsumi / Bloomberg
The IMF itself warned in the wake of this global financial crisis that "many countries will have to make major cuts in the future," but now it is calling on all countries that have access to financial markets to issue debts and later to spend without the prospect of austerity. Kristalina Georgieva, head of the IMF, said when she was inspired by the Russian writer Fyodor Dostoyevsky: "Only one thing is important – to be able to dare".
Both advanced and many emerging economies have taken the advice very seriously in the fight against the coronavirus. The IMF estimates that countries have so far increased their spending or cut taxes by USD 11.7 billion – 12 percent of global gross domestic product in 2020. To put this into perspective, the G20 countries voted a little more than a decade and after months of contention finally to an incentive worth 2 percent of global GDP for two years after the financial crisis.
In financial terms, this time is really different.
The fiscal consensus that had prevailed up to the last few years was based on the lessons learned internationally after the boom decades of the 1950s and 1960s. Experience showed that increasing or decreasing taxes and changing public spending in most political systems were too slow to effectively tame the business cycle and instead tended to reinforce it. Monetary policy – ideally set by independent policy makers in central banks – took on this role.
The second part of this fiscal consensus accepted that the best policies aim at longer term stability of public finances and ensure that debt and deficits comply with the general rules of thumb that almost always ensure that compliant countries have no difficulty in self-financing. This would allow them to focus on improving the efficiency of their tax systems and public spending.
This consensus was still prevalent at the time of the 2008-09 financial crisis and culminated in the 2010 G20 Toronto Declaration, which highlighted "the importance of sustainable public finances" and warned that "countries with serious fiscal challenges should Consolidation need to accelerate ”. Greece, for example, had already lost the trust of its lenders.
Fiscal over monetary policy
The question now is why thinking has changed so radically. The responses cover three different categories: bitter experiences of the past decade, changed circumstances, and rough politics.
There is no doubt that the 2010s was a difficult decade for almost all economies around the world, and underlying growth was significantly less than hoped for at the time of the Toronto Summit. Most of this had more to do with global declines in underlying productivity performance than with tax and public spending strategies, but even with diminished growth potential, economic performance disappointed, largely because monetary policy did not have the ammunition to stimulate economies enough .
The world's great economic blocs have never reached the conditions that would have led to rapidly rising wages and inflation so that interest rates could rise to more normal levels, despite officials like Mario Draghi of the European Central Bank "doing whatever it takes". Monetary policy simply could not have brought about the $ 11.7 billion rebound that fiscal policy managed this year.
An anti-austerity protester interrupted the then President of the European Central Bank, Mario Draghi, at a press conference in 2015. Monetary policy simply could not have brought about the $ 11.7 billion boost that fiscal policy managed this year. © Ralph Orlowski / Reuters
After the last decade, instead of jealously guarding their independence, central leasing central bankers speak of the need for fiscal policy to prevent the fall in inflation. In the past few weeks, Federal Reserve chairman Jay Powell said "the recovery will be faster if both instruments (fiscal and monetary) work together," while Governor of the Bank of England Andrew Bailey called for "a very narrow and reasonable demand." Coordination ”of the two economic policies.
Long gone is the notion, endorsed by former British Chancellor George Osborne, that it is imperative to have a credible public finance deficit reduction plan as this would give households confidence to spend, rather than to save up.
There are also economic circumstances that until recently did not apply. The main change, highlighted primarily by Olivier Blanchard, former chief economist at the IMF, is that countries could afford to service significantly higher levels if government borrowing costs in advanced economies were below or near advanced economies Zero debt without putting more of a strain on your finances in the long run, as economies would likely grow faster than the interest rate on debt. "Issuing debt without a later hike in taxes may well be feasible," said Prof. Blanchard in January 2019.
The example he gave was a one-off spike in debt, which at the time was viewed as an otherworldly scenario because few countries in peacetime have ever borrowed a huge amount of money for a strictly limited period of time. But in 2020, the pandemic arguably created precisely that situation, and the IMF used the unique nature of deficits as a justification for supporting the large-scale lending countries raised.
Jay Powell, chairman of the Federal Reserve, said recently, "The recovery will be faster if both tools (fiscal and monetary) work together." © Kevin Dietsch / Pppl / AFP via Getty
After all, after the difficult 2010s, there is no longer any desire for austerity measures, so that the political and public mood fits in with the new economy. The austerity measures arguably laid the foundation for their own destruction by backing populist politicians like Donald Trump and Boris Johnson who didn't have a truck with tough budget issues and rarely saw a problem with the size of public spending.
In the aftermath of the financial crisis, President Barack Obama and Democratic politicians teamed up with Republican fiscal hawks to reduce the US deficit and Donald Trump's popularity with huge tax cuts in 2017. Joe Biden, the Democrat, has no mood presidential candidate to play that game again if he wins on November 3rd.
Prominent economists and former Democratic Party officials, Jason Furman and Larry Summers, provided the intellectual foundation for changing the party's stance. They argued last year that lowering government bonds still had costs and benefits, but "the benefits of a reduced likelihood of a financial crisis do not outweigh the costs of reducing deficit".
In Great Britain, Boris Johnson's conservative government has ruled out austerity as a means of solving the country's public financial problems, and even in Germany, the bastion of fiscal honesty, politicians such as Economics Minister Peter Altmaier are now boasting of "the greatest economic stimulus plan" of all time " in response to the coronavirus.
Kristalina Georgieva is the head of the IMF, which is now telling all countries that have access to the financial markets to issue debt and later to spend it without the prospect of austerity. © Eric Baradat / AFP
Too early to bury austerity
However, it would be wrong to say that everyone has joined the new consensus that deficits and government debt no longer matter. There are also tensions within the IMF. While the executive is urging countries to try new things, officials continue to insist on austerity measures for countries forced to borrow from the fund.
Oxfam, the charity against poverty, has complained that the IMF has put austerity measures against 80 percent of countries forced into their loan programs during the coronavirus pandemic. "These austerity measures will hurt the countries they want to help and will fly, given the Fund's own research, which shows they worsen poverty and inequality," said Ana Arendar, director of inequality at Oxfam.
But it's not just lenders who fear that countries may need a more conservative approach to fiscal policy over time.
"Much will depend on whether the fiscal legacy of the virus is merely a gradual increase in the debt ratio – due to a large but temporary spike in additional credit," said Robert Chote, who has just stepped down as head of the UK's budgetary responsibility. “Or whether we are also faced with a sharp rise in the structural budget deficit.
Former UK Chancellor George Osborne felt it was imperative to have a credible plan to reduce public finance deficits as this would give households confidence to spend instead of save. © Charlie Bibby / FT
"An increase in the structural deficit would strengthen the case for fiscal consolidation (austerity), but you still don't want to act too quickly," he adds.
In the UK, the Institute for Fiscal Studies warns that the crisis is likely to require higher health and social spending in the future, well beyond the benefits of lower borrowing costs. This week the UK will ultimately have to find tax hikes of likely around 2 percent of GDP to contain what is likely to be a sustained rise in public debt.
Given the aging of the population in advanced economies, this is likely to become an increasingly pressing problem over the next decade. Austerity measures may have been buried for now, but if the luck of governments doesn't hold the cost of borrowing, and if aging sets in, there is no guarantee they won't be revived.