Pandemic and 'fiscal stimulation'

'Fiscal policy must play a leading role in the recovery. Governments can productively counter the shortfall in aggregate demand. Credit facilities installed by monetary authorities can only assure the power to lend but not to spend... Fiscal authorities can actively support demand through cash transfers to support consumption and large-scale investment in medical facilities, digital infrastructure and environment protection. These expenditures create jobs, stimulate private investment and lay the foundation for a stronger and greener recovery.' - 'Global liquidity trap requires a big fiscal response' by Gita Gopinath, chief economist of International Monetary Fund (IMF).

It needs to be mentioned from the outset that usual IMF stabilization programmes of aggregate demand squeeze make little sense in the wake of the pandemic. This is because such lopsided programmes have traditionally come under severe criticism on account of being too harsh on growth and poverty. Having said that while monetary easing, both through the instrument of policy rate reductions and unconventional means, have provided a lot of cushion since the start of the pandemic, yet pandemic-related uncertainty and low aggregate demand have not allowed businesses to make use of that money; especially in developing countries where such easing was relatively a lot less than in developed countries. Hence, the current programme of IMF with Pakistan needs reorientation of conditionalities that boost aggregate demand, primarily through greater public investment, and that pushes for deeper institutional reforms on the aggregate supply side.

Overall, businesses that have reasonably enough borrowing strength and can access loanable funds at low cost, but are in a 'liquidity trap' - a situation where low interest rates do not cause expansion in investment but saving - and households which have little cash to start with, both require active role of fiscal policy. This is important for not only addressing broader concerns that originate from the deep level of recession in the wake of the pandemic, and is important to some extent in dealing with the solvency concerns in the economy, as aggregate demand picks up in the wake of fiscal stimulation, yet in the short-term a much greater debt relief effort is needed. This is necessary for both dealing with current immense burden of debt overall, and also, providing needed space for governments, especially in developing countries, to raise new debt to increase much-needed public investment. In this regard, continued monetary easing would also be needed to bring greater affordability to fresh loans being raised.

Institutional reform in Pakistan, through both a reoriented IMF programme, and active government policy in general would mean greater confidence of both domestic and foreign investors to invest more readily beyond the stock market, which is a limited representative of the performance of real economy where actual jobs and growth happens. Broader domestic investment also requires such a reform effort, in addition to greater public spending, for laying the much needed basis for private sector in these uncertain times and low aggregate demand. The recession and increasing levels of poverty mean therefore that domestic resource mobilization would most likely remain a weak link for financing needed levels of enhanced public investment, for which it will be important, in addition to institutional reforms, to engage creditors - domestic and foreign - for greater debt restructuring/relief. Perhaps, the current IMF programme could be used as a platform to initiate and introduce workable debt mechanisms to this end.

The pronounced impact of the pandemic due to its manifestation for both patients and economies in the shape of 'long Covid' indicates the likelihood of a rather prolonged liquidity trap being unfolded, which means that the returns of fiscal stimulation will most probably bring greater returns in terms of impact on economic growth. This is due to the likely presence of a relatively larger 'fiscal or spending multiplier' producing greater multiplier impact of public investment on economic growth. Christopher Erceg and Jesper Lindé, in their (2014) research paper 'Is there a free lunch in a liquidity trap?' highlight the likelihood of this happening in the following words: 'If the liquidity trap is very prolonged, the spending multiplier can be much larger than in normal circumstances, and the budgetary costs minimal. Gita Gopinath in the same article highlights this in the following manner: 'The importance of fiscal stimulus has probably never been greater because the spending multiplier - the pay-off in economic growth from an increase in public investment - is much larger in a prolonged liquidity trap.'

Hence, this provides all the more reason for Pakistan to adopt an active fiscal policy stance. The IMF should support this, especially when its chief economist Gita Gopinath in a recent interview to Financial Times pointed out: 'There is consensus that fiscal stimulation was withdrawn too quickly right after the financial crisis. And that is a mistake that we want to avoid happening again... An important lesson that was learnt after the financial crisis is that fiscal policy plays an essential role in recovery. And every increase in debt does not sow the seeds of destruction... The point is that there are good forms of public investment that can create jobs, enhance economic activity while also being fiscally prudent, in the sense of helping to bring down debt to gross domestic product levels.'

(The writer holds PhD in Economics from the University of Barcelona; he previously worked at International Monetary Fund) He tweets@omerjaved7

Copyright Business Recorder, 2020