Economics and finance, Government and governance | Australia, The World

28 May 2020

In the wake of COVID-19, governments across the political spectrum are likely to adopt a more hospitable stance towards fiscal spending, Roman Darius writes.

The COVID-19 crisis has created the conditions for an enduring rebalance in policy orthodoxy, from fiscal conservatism and overreliance on monetary policy to greater fiscal spending and state intervention in the economy. There are two aspects to this shift.

First, there is a monetary aspect. As the deployment of unconventional monetary measures has further reinforced the near-zero interest rate regime across the developed world, the diminished effectiveness of additional monetary stimulus has solidified the urgency of fiscal policy. Simply, the monetary measures at the disposal of central banks will no longer be adequate in countering economic downturns absent large-scale fiscal stimulus.

The second is social. After the pandemic, citizens, who have seen the power of policymakers to act when it is truly needed, will lean on governments for intervention, in particular to meet economic needs. Already widespread, these calls may become even more common. Together, both of these forces are likely to displace the policy orthodoxy of minimal state intervention – one that has dominated public policy for the past four decades.

The economic turmoil of the 1970s, with high inflation and unemployment, swung the policy pendulum away from fiscal initiatives and higher spending in favour of monetary policy and fiscal minimalism.

This transformation in policy orthodoxy corresponded with an ideological shift from Keynesianism, with its focus on government spending and intervention in the economy, to those which delegated a more limited role for the state. Namely, Milton Friedman’s monetarism and Friedrich Hayek’s liberalism, with the broad merger of the two forming the prevailing neoliberal model.

Vindicated by the economic challenges of the time, the model has been extraordinarily influential since the Thatcher-Reagan era in orienting public policy towards greater reliance on monetary policy alongside fiscal conservatism, manifesting in privatisation, outsourcing, supply-side economics, and market and trade liberalisation. Yet, just as the limits of fiscal policy in the 1970s precipitated the shift away from government intervention, today it is the limits of monetary policy that will engender its revival.

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The financial crisis of 2008 led central banks across the world to embark on a substantial and protracted program of quantitative easing, leading to a monetary environment across the developed world of near zero interest rates, alongside below-target inflation.

What this signified was that the scope of expansionary monetary measures at the disposal of central banks had been exhausted. The diminished effectiveness of monetary policy would in turn elevate the need for fiscal measures – that is, more government spending.

This was the central thesis behind Allianz chief economic advisor Mohamed El Erian’s 2016 publication The Only Game in Town. El Erian was not alone in his analysis of the problem and the necessary prescription. In 2019, former Treasury Secretary Lawrence Summers reinforced his longstanding position on the urgency of fiscal stimulus, especially given the diminished capacity of expansionary monetary policy.

The most definitive plea for a reassessment in favour of fiscal policy however, was expressed by an editorial in the Financial Times this year, which prior to the outbreak of the coronavirus made the case that a recalibration toward fiscal policy was long overdue. The editorial stated that the era of monetary policy as the dominant instrument of macroeconomic policy should have ended years ago.

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The current crisis has served as a baptism of fire in awakening policymakers to the urgency of increasing government spending in the economy. As both governments and publics awaken to the social and economic necessity of prioritising fiscal stimulus over balanced budgets and deficit reduction, the political shift underway will, and indeed already has, led to a fundamental reassessment of the socioeconomic role of the state.

Over the past several months, governments across the political spectrum have expanded welfare provisions, subsidised wages, and inaugurated new public services. In recent history during the financial crisis of 2008, large stimulus measures were often met with staunch opposition, leading to such phenomenon as the Tea Party movement in the United States and a decade of austerity in Britain. Today, such opposition is few and far between.

Even prior to the outbreak of the coronavirus there were many indications that the neoliberal prescription of fiscal minimalism had reached the limits of its efficacy. The world post-2008 financial crisis, with tepid growth, near-zero interest rates, and low inflationary pressures was a far cry from the stagflation of the 1970s.

While for a brief period in the aftermath of the financial crisis governments did deploy large-scale fiscal measures, the narratives of budgetary emergencies and debt crises prevailed. By 2010, the concerns over ‘fiscal sustainability’ subordinated the impetus for growth, as the consensus amongst leaders of the G20 shifted from fiscal stimulus to fiscal consolidation.

Despite continued lackluster growth and low inflation however, the doctrinaire attachment to fiscal conservatism at the policy level persisted. As the Frank Sinatra line goes, “the music had stopped but we were still dancing.”

But now, the economic consequences of the coronavirus have violently rendered the old paradigm obsolete. The nature of the shock, coupled with diminished effectiveness of expansionary monetary policy, has made fiscal stimulus an economic imperative. A rebalance in favour of greater interventionism will no longer be a luxury of choice for policymakers, but a necessity for the survival of economies.

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