Global Fiscal Stimulus Needed, IMF Officials Argue

by Ulrika Lomas, Tax-News.com, Brussels

02 January 2009

In a recent interview conducted by the IMF Survey Magazine, International Monetary Fund officials Olivier Blanchard, Economic Counsellor, and Carlo Cottarelli, Director of the Fiscal Affairs Department, repeated the call for global fiscal stimulus action initially made by IMF Managing Director Dominique Strauss-Kahn following the November 15 emergency meeting of leaders of the Group of 20 (G-20) industrialized and emerging market economies.

When asked what a fiscal stimulus could achieve that cuts in interest rates or bank restructuring haven't been able to fix, Blanchard explained to IMF Survey that:

"The question is not what policy, but what set of policies, to pursue. Three types of measures are needed, and they need to be implemented in parallel."

"First, we need to repair the financial system by recapitalizing banks and isolating bad assets. Frameworks have been put in place, but execution is complex and will take time. Only when this is achieved can we hope for a sustained flow of credit and a lasting recovery."

"Second, we should use monetary policy to increase demand. Here, the room for further monetary easing — at least in a traditional sense — is shrinking: in some countries, policy interest rates are approaching zero. Moreover, the effect of lower interest rates on demand is weakened by the disruption in credit markets."

"This point to a central role for the third set of measures, fiscal stimulus. In the short run, such a stimulus, if designed right, can limit the decline in demand as well as output. Our article talks about what 'designed right' means in the current circumstances."

Commenting on what policies governments should adopt, Cottarelli observed that:

"I would make two points here. Given the complexity of this crisis, policymakers have to recognize that there is an unusual degree of uncertainty about the impact of specific policies. Thus, they should not put all their fiscal eggs in just one basket, and the right package probably includes a mix of different policies."

"As for the balance between spending increases and tax cuts, we think that there are two arguments why spending increases should be part of the package, probably more so than in the past."

"First, the decline in private sector demand is likely to be prolonged. This implies that fiscal policy can rely more than in the past on spending measures, including investment in infrastructure, because we don't need to worry so much about implementation lags.

Second, we believe that, in the current circumstances, the marginal propensity of consumers to spend tax cuts or transfers may be low, leading to low multipliers. That said, selectivity is needed in raising spending: direct purchases of goods by the government – investment spending in particular – has a direct effect on demand and will also have positive supply-side effects. In contrast, increasing public sector wages is unlikely to help and may be difficult to reverse."

He continued:

"Credit conditions have tightened as banks have reduced credit lines or increased interest rates. And high uncertainty is leading many consumers to take a wait-and-see attitude, for example, waiting to buy a car until they have a better sense of how bad the recession is likely to be."

"This gets me back to the issue of tax cuts: Consumers who are credit constrained are likely to spend any extra money derived from a lower tax bill. But wait-and-see consumers are more likely to save any extra cash."

"That's why tax cuts and transfers targeted to the most cash-strapped consumers would probably work best. Some examples of policies we think would work better include extending unemployment benefits, increasing earned income tax credit or equivalent tax cuts targeted to households that are likely to be credit constrained, and expanding social safety nets. In come countries, governments may want to support homeowners facing foreclosures."

Finally, commenting on the risk that the taxpayers in some countries will end up unfairly bearing the burden of their counterparts in other countries, Blanchard concluded by explaining to IMF Survey that:

"When economies are linked by a high degree of trade openness, fiscal expansion in one country translates in part into an increase in demand for the goods of other countries, and so may result in a larger trade deficit. Thus, each country is, rightly, reluctant to embark on a fiscal expansion on its own."

"The best solution is for all countries to act jointly. But this requires some form of commitment or coordination. This is why the IMF has been closely engaged in discussions with member countries on how to design an appropriate fiscal response. Given our global membership, we are uniquely placed to do so."

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