The International Monetary Fund is doing the world a great service by advocating to its membership the need for strong fiscal policy support at a time that the coronavirus pandemic is plunging the world economy into its worst economic recession in the past ninety years. However, it is doing the United States a great disservice by downplaying the risks that too cavalier an attitude towards budget policy loosening could lead to serious debt problems down the road.
The IMF’s seeming shift to a more relaxed fiscal policy attitude is all the more disappointing coming as it does at a time that Modern Monetary Theory is gaining currency and at a time that there seems to be no longer any serious constituency for disciplined public finances. If the IMF no longer seems to subscribe to the need for sound public finances, then why should any politician subscribe to such a view?
The appropriateness of the IMF’s advocacy for aggressive budget policy support at this time would seem to be beyond question. It is not simply that the world is now experiencing its deepest economic recession in the past ninety years. It is not simply that the world economic recovery is already showing signs of running out of steam just as a second wave in the pandemic threatens to do further damage to the global economy. It is also that the world’s central banks seem to be running out of road to provide the economy with further monetary policy support.
With world interest rates already at or close to their zero bound, there would now seem to be little room for further interest rate reduction. Meanwhile, with asset prices already at elevated levels and with credit markets already distorted, the world’s central banks would risk further contributing to world financial market vulnerabilities if they were now to increase their pace of government bond purchases.
Where the IMF’s views on budget policy can and should be questioned, is its seeming belief that the strong budget policy response to the pandemic might not be putting countries at the risk of serious public debt problems down the pike. The IMF is now basing its view on the belief that interest rates will stay low for very long, which will allow countries to grow their way out of their public debt problems.
This belief is inducing the IMF to now support its relaxed attitude toward budget policy stimulus with rather rosy projections about its members’ long-run public debt paths. According to its latest Fiscal Monitor Report, it is now projecting for instance that the U.S. general government debt to GDP ratio, after skyrocketing from 108 percent in 2019 to 131 percent in 2020, will somehow stabilize at around 130 percent thereafter. Similarly, it is projecting that even for a country like Italy, whose public debt to GDP ratio will have risen from 135 percent in 2019 to 160 percent in 2020, will somehow stabilize at that level thereafter.
The factor that makes the IMF’s rosy public debt forecasts highly implausible is the strong budget policy tightening in 2021 that would be needed to secure a stabilization of the public debt to GDP ratios. According to the IMF’s own estimates, to attain debt stabilization the United States would need to reduce its cyclically adjusted primary budget debit from 13 percent of GDP in 2020 to less than 6 percent of GDP in 2021. Similarly, Italy would also need to reduce its primary budget deficit by a full 7 percent of GDP.
Such a strong budget adjustment at a time that a weak economy is likely to be hit by a second wave of the pandemic has to raise fundamental questions. Would the U.S. and Italian economies really be able to sustain the sort of strong economic recovery that the IMF is anticipating to help improve their public debt pictures if they were at the same time to have to engage in substantial belt-tightening next year?
All of this is not to say that the IMF is mistaken in advocating a strong fiscal policy response to the coronavirus pandemic. Rather it is to say that the IMF should be a lot more vocal about the long-term risks posed by such a fiscal policy response to the longer-run health of its member countries’ public finances. Had the IMF been more sensitive to those risks, then it might have cautioned its member countries to exercise the greatest of care in targeting their fiscal policy response to the pandemic in order to make sure that they did not increase their long-run public debt vulnerabilities beyond what was absolutely necessary.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.