It is refreshing to see some international organization take firm positions on the macroeconomic policy debate. Even as the debate about the specific policies to be followed to boost aggregate demand continues, the IMF appears to have taken the view that direct public spending may be the most effective option. Interestingly, in a Vox article, Olivier Blanchard and his colleagues (full paper here) feel that implementation lags and standard fiscal multipliers may be of limited relevance given the long drawn out and peculiar nature of the crisis, and points towards policy diversification with focus on direct public spending (as opposed to taxes and transfers) to raise aggregate demand. They also feel that, in order to minimize uncertainty, the policy makers should signal that they are committed to doing whatever is needed to restore normalcy.
They have the following seven pre-requisites for any fiscal stimulus to come out of a financial crisis induced recession
1. timely (as there is an urgent need for action),
2. large (because the drop in demand is large),
3. lasting (as the recession will likely last for some time),
4. diversified (as there is uncertainty regarding which measures will be most effective),
5. contingent (to indicate that further action will be taken, if needed),
6. collective (all countries that have the fiscal space should use it given the severity and global nature of the downturn), and
7. sustainable (to avoid debt explosion in the long run and adverse effects in the short run)
They also draw fourlessons from previous brushes with financial crises
1. Successful resolution of the financial crisis is a precondition for achieving sustained growth; delaying action led to a worsening of macroeconomic conditions, resulting in higher fiscal costs later on.
2. The solution to the financial crisis always precedes the solution to the macroeconomic crisis.
3. A fiscal stimulus is highly useful (almost necessary) when the financial crisis spills over to the corporate and household sectors with a resulting worsening of the balance sheets.
4. The fiscal response can have a larger effect on aggregate demand if its composition takes into account the specific features of the crisis.
To boost public spending, it favors governments relaxing balanced budget norms, making transfers to state and local governments, and focussing spending programs on repair and maintenance, re-starting incomplete, delayed and post-poned investment projects. It does not favour broad-based tax cuts for consumers, but prefers greater provision of unemployment benefits, increases in earned income tax credits, and the expansion of safety nets. For firms too, instead of tax cuts and direct subsidies, it feels that the priority should be to ensure that firms do not reduce current operations for lack of financing, which in turn means keeping the credit markets open and active by providing some form of government guarantees on new credit.
The authors also hint at governments being better positioned than private investors to buy and hold distressed private assets, and partly replace the private sector in financial intermediation. They also float the proposal for a provision of insurance by the public sector against large recessions by offering contracts, with payment, contingent on GDP growth falling below some threshold level. And finally, it calls for a concerted effort by the international community, and stricter coordination among countries with closer economic and institutional ties.
The irony of these prescriptions, especially that against balancing budgets now and preference for direct public spending as against tax cuts, are that these are precisely the opposite of what the same IMF had prescribed to Latin American and East Asian economies in previous crises.
More on IMF and fiscal policy prescriptions is available here.
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