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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