Coronavirus has enveloped the world in a cloud of uncertainty. And while the viral shock affected all countries, the economic and social consequences have revealed considerable differences in initial conditions—such as the quality of health and social care, the importance of social consumption and fast broadband coverage. But the pandemic has also exposed two aspects of the policymaking process: the quality of political decision-making and the space for monetary and fiscal policy to provide temporary support for households and firms. The varied deployment of monetary and fiscal tools tells us not only about the advantages that advanced economies have, but also about the more abrupt and damaging adjustments that many emerging and poorer economies are facing.
Most advanced countries have been able to exploit their policy space to support firms who have suffered temporary losses in revenue and households who have shed jobs and income. Prompt action by central banks in the spring of 2020 has prevented any obvious dislocations in financial markets, and the banking system seems to be well placed after the global financial crisis—better capitalised and holding more liquidity than it did in the first decade of this century. But the main support has been offered by fiscal policies that have cranked up public debt in advanced economies to some 15-20 per cent of GDP. Nowhere exemplifies this more than in the US, where a fiscal injection of some 9 per cent of US GDP has accelerated growth so that the economy is expected to return to its pre-crisis level of activity at mid-year. But at the same time, supply chain shortages and step changes in many commodity and producer prices has prompted increasing concerns that goods will follow asset prices and suffer a sustained inflation.
And for both strands of policy, we can detect a change in tone. The period after the great inflation of the 1970s and early 1980s, a formative period for me, set the standard for orthodox policies directed at price stability and sound money. The building blocks of this approach were an inflation target and the pursuit of stable or falling levels of public debt to income. The moves to change the target of the Federal Reserve and increase the explicit target of the European Central Bank do not by themselves undermine price stability, although many have asked if they could. Many have also argued for an increase in the inflation target, which I do not support.
On fiscal policy, the tide has turned away from arbitrary targets, such as those enshrined in the Maastricht criteria and in myriad IMF lending programmes, to a more sensible view that it is a tool to manage risks rather than an instrument that cowers in the face of realised risk. Our own work in fiscal frameworks is instructive. We need less of rule but more of active approach to fill obvious gaps in the provision of public goods. Here advanced economies are at a distinct advantage, as they can issue debt which is treated as risk-free and hence capture some fraction of the pool of savings that might best have been devoted to poorer countries where the social rate of return is almost certainly higher. They could also, if they had the foresight, develop better aid and support programmes for poorer nations that will tend to foster trade and productivity on both sides of the exchange.
Clearly the benevolent dictator that does not run the world might stack up some of these developments differently. Advanced economies have insulated themselves from economic shocks and also then had first dibs on the vaccines. Are our institutions for ensuring equitable distribution of finite resources insufficiently strong to bring about a better allocation? It does sound that we in the advanced economies of the world are having our cake and eating it, and then complaining about the resulting case of obesity. The IMF’s new issue of Special Drawing Rights (SDR) will support the liquidity position of poorer countries but so would agreeing to free vaccine supply from the constraints of intellectual property.
Ultimately the real test of any new framework will be whether we can adopt new ways to co-operate over man-made climate change at this year’s COP26. Regarding both the pandemic and global warming the same maxim applies, with the same implication for sustained international co-operation: this won’t end for anyone until it ends for everyone.
