FISCAL POLICY - NEED OF THE HOUR

  Post by: Sarvesh

  The world is in the grip of the COVID-19 pandemic and the ensuing Great Lockdown has pushed many countries into deep recessions—worse than during the 2008–09 global financial crisis. In response, governments and central banks all over the world have introduced a strong discretionary (one-off and specific) fiscal and monetary measures to counteract the economic fallout caused by the spread of the coronavirus. Existing automatic stabilizers (such as income-based taxes and unemployment and household benefits), which differ across countries, have generally operated freely, providing some further cushion.

FOR MORE UPDATES ON OUR BLOG, JOIN OUR WHATSAPP GROUP AND REDDIT PAGE

What is a FISCAL POLICY?

    Fiscal policy is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy. It is the sister strategy to monetary policy through which a central bank influences a nation's money supply. These two policies are used in various combinations to direct a country's economic goals. Here's a look at how fiscal policy works, how it must be monitored, and how its implementation may affect different people in an economy.

    Like Mitton Friedman "cutting government spending and government intrusion in the economy will almost surely involve immediate gain for the many, short term pain for the few, and long term gain for all.

   There are two types of fiscal policy. The most widely-used is expansionary, which stimulates economic growth. Congress uses it to end the contraction phase of the business cycle when voters are clamouring for relief from a recession. The government either spends more, cuts taxes or both. The idea is to put more money into consumers' hands, so they spend more. The increased demand, forces businesses to add jobs to increase supply.

When interest rates are high, the money supply contracts, the economy cools down, and inflation is prevented. When interest rates are low, the money supply expands, the economy heats up, and a recession is usually avoided.

A larger role for fiscal policy

    With interest rates at or near zero in advanced economies, the scope for further conventional rate cuts is limited. But central banks may still use unconventional monetary policy tools more intensively—like large-scale asset purchases—to deliver additional support, as they have recently in response to the pandemic. However, relying on monetary policy alone to respond to shocks might not be enough and also raises questions about side effects on future financial stability and threats to central bank independence.

    While keeping an eye on debt sustainability concerns over the long term, fiscal policy needs to play a larger role. Putting in place more automatic fiscal responses in advanced economies could help build their resilience to future adverse shocks. If rules for fiscal stimulus are well communicated and established before shocks occur, they can help shape expectations and reduce uncertainty, thereby dampening the drop in the activity once a negative shock materializes

    This study shows that rules-based fiscal stimulus measures—such as temporary targeted cash transfers to liquidity-constrained, low-income households that kick in when the unemployment rate rises above a certain threshold—could be highly effective in countering a downturn caused by a typical demand shortfall. Although these stimulus measures would be automatic, they are very different from traditional automatic stabilizers, which instead respond to an individual’s circumstances (for example, being laid-off in the case of unemployment insurance or lower incomes in the case of progressive income taxes). Rules-based fiscal stimulus is particularly effective when interest rates are at their effective lower bound (when rates cannot be cut further) and discretionary fiscal policy lags are long. Moreover, fiscal stimulus after demand shocks tends to be especially powerful when the economy has unemployed resources and monetary policy is accommodative.

    The current economic shock from the pandemic is unusual as it has affected both supply and demand. Even though the political will for action has rapidly coalesced in response to the current shock, its unrivalled speed and depth have complicated the design and timely delivery of discretionary fiscal support. When workers and firms are unable to operate while the epidemic is active, the effectiveness of fiscal stimulus to boost output (the multiplier) is low. Nonetheless, even in these circumstances, a rules-based fiscal stimulus implemented ahead of time could have been helpful, especially in the form of targeted transfers. These measures could provide further income insurance and strengthen the social safety net for the vulnerable.

    This does not mean that discretionary fiscal policy becomes redundant. In fact, discretionary fiscal measures, appropriately tailored to the specific circumstances and the nature of the negative shock—like the pandemic shock—are essential to provide powerful countercyclical support. But they must be adopted and deployed in a timely manner.

A more agile response to future recessions

    Given historical delays in the implementation of discretionary fiscal stimulus and the helpful effects of setting expectations by adopting rules for action in advance, there is a strong case for a more automatic fiscal response to economic downturns. Our analysis shows that adopting rules-based fiscal stimulus measures can be highly effective and more timely, particularly when central bank interest rates are close to or at their effective, lower bound and monetary policy is constrained.

FOR MORE UPDATES ON OUR BLOG, JOIN OUR WHATSAPP GROUP AND REDDIT PAGE

Reference:

https://blogs.imf.org/

https://www.investopedia.com/insights/what-is-fiscal-policy/

https://www.quotemaster.org/images/a2/a2c63555c1864e145aaea452638a2122.jpg

https://www.thebalance.com/what-is-fiscal-policy-types-objectives-and-tools-3305844