Rethinking Fiscal Policy for Global Recovery
Anis Chowdhury was Professor of Economics, University of Western Sydney, and held various senior United Nations positions in New York and Bangkok. Jomo Kwame Sundaram was UN Assistant Secretary- General for Economic Development.
KUALA LUMPUR, Malaysia, Jun 23 2016 (IPS) – Global economic recovery is being held hostage by the ideological dogma of the last three and a half decades. After long contributing to neo-liberal conventional wisdom, in its October 2015 World Economic Outlook, the IMF identified the vicious circle undermining global recovery and growth. Low aggregate demand is discouraging investment; slower expected potential growth itself dampens aggregate demand, further limiting investment.
Investment in Europe, especially in crisis-ridden economies, has collapsed sharply despite very low interest-rates. The IMF also noted that prolonged recessions may have a permanent negative effect, not only on trend productivity levels but also on trend productivity growth as well as wage growth that, in turn, sustains low aggregate demand.
The rise of fiscal policy
From the mid-1930s until about the mid-1960s, fiscal policy has played a major role, both in developed and developing countries. The fiscal deficit was the main policy instrument to address the Great Depression of the 1930s and later, to maintain full-employment in developed countries. Deficits and surpluses were adjusted counter-cyclically over business cycles. In his 1936 budget speech, President Roosevelt noted, “the deficit of today … is making possible the surplus of tomorrow.”
Governments in developing countries have played a major role in building infrastructure and providing basic public services such as health-care and education. They often did not have the resources, domestic or foreign, as war-torn Europe had with the Marshall Plan, to rebuild their economies.
Thus, the main way to develop their newly decolonized countries was by running deficits, financed by printing money. This was also the case when the US emerged as a newly independent nation. Alexander Hamilton, the first US Treasury Secretary under President Washington, incurred debt to establish “sound credit”, laying the foundation for a robust future market in US debt.
There was a brief revival of fiscal activism when the 2008-2009 financial crisis hit the global economy. Developed countries responded with large fiscal stimulus packages, in addition to bailing out troubled financial institutions. Major developing countries also put in place carefully designed fiscal stimulus packages that included public infrastructure investment and enhanced social protection measures.
But instead of recognizing that deficits and surpluses should be adjusted counter-cyclically over business cycles rather than being held hostage by financial markets, this moment was soon lost to claims of ‘green shoots of recovery’ once the most influential financial interests had been saved.
The fall of fiscal policy
With the counter-revolution against Keynesian and development economics in the late 1970s and early 1980s, budget deficits became taboo. The fall from grace of fiscal policy followed the ascendancy of market-fundamentalist conservative politics with the election of Margaret Thatcher in the UK and Ronald Reagan in the US.
The conservative distrust of governments favoured rule-based policies to curb discretionary government spending, including the US Gramm-Rudman-Hollings deficit-control legislation and the EU’s Stability and Growth Pact that set a 60 percent debt-GDP ratio ceiling. In fact, debt is sustainable if government expenditure enhances both growth and productivity. The claim that government deficits will need to be ‘financed’ with higher tax rates in future is spurious as revenues are bound to rise in an expanding economy.
Understanding this requires abandoning the narrow concept of “sound” finance in favour of “functional” finance, which evaluates government finance based on its impact. Thus, for Abba Lerner, “The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound or unsound.”
Crowding-out or -in
A lingering concern is financing the deficit. The first recourse for governments is to borrow domestically, raising the spectre of “crowding-out”, i.e. government borrowings driving up interest rates, adversely affecting private investment. This view ignores the consequences (e.g. low profitability, bankruptcies, etc.) of a depressed economy. After all, government action is necessitated, in the first place, by inadequate private spending.
Moreover, the immediate financial implication of expansionary policy action is to augment the cash reserves of private sector banks where government cheques are deposited. This, in turn, increases (net) liquidity if the central bank does not implement offsetting money market operations. Hence, the actual central bank discount rate should decrease, exerting downward pressure on retail interest rates. This should, therefore, encourage, rather than crowd-out private investment.
In its October 2014 World Economic Outlook, the IMF favoured an infrastructure push in the face of low borrowing costs and weak aggregate demand. It also observed that “debt-financed projects could have large output effects without increasing the debt-to-GDP ratio if clearly identified infrastructure needs are met through efficient investment”. Maintaining this favourable view of debt-financed public investment, the IMF’s October 2015 World Economic Outlook asserted that debt-financed public investment in infrastructure, education, health and social protection would boost aggregate demand and productivity.
As outgoing Reserve Bank of Australia governor, Glenn Stevens has pointed out, “the impediments… are not financial. The funding would be available, with long- term interest rates the lowest we have ever seen or are likely to…The impediments are in our decision-making processes and, it seems, in our inability to find a political agreement on how to proceed.”