Sunset in Frankfurt. There are many reasons to think fiscal consolidation will not be anywhere as necessary as it may first appear
There are many reasons to think fiscal consolidation will not be anywhere as necessary as it may first appear © AP

There is, thankfully, a lot of debate about how to rebuild a better economy after the coronavirus lockdown. A month ago, I wrote that the biggest question for economic policy was whether the aim should be to restore the status quo ante or take the opportunity to seek fundamental change. Today, few people think we can ever go back to the pre-crisis normal, and the conversation has moved on to the contest for how things ought to change.

One particularly contested point is what to do about public finances. As I wrote in previous instalments of this series, persistent strong demand stimulus is necessary to contain inequality and to make labour markets both fairer and more productive. Against this stands the very natural worry that public deficits and debt will have increased by so much that a period of belt-tightening is unavoidable. For example, Capital Economics forecasts debt-to-GDP ratios in Greece, Italy and Portugal will hit 220 per cent, 180 per cent and 150 per cent respectively.

Willem Buiter sets out the clearest argument I have seen for expecting a lasting burden on public finances — he foresees both permanently lower growth and political pressure for more redistribution — that would require a painful combination of tax rises and spending cuts. And where the pain is going to fall will, as always, be one of the most contested questions of all. As Adam Tooze warned a few weeks ago: “A world in which coronavirus debts are repaid by a wealth tax or a global crackdown on corporate tax havens would look very different from one in which benefits are slashed and VAT is raised.”

But we should not count our chickens before they hatch, or in this case, rush to allocate the fiscal pain too soon. For there are many reasons to think fiscal consolidation will not be anywhere as necessary as it may first appear — and indeed that public coronavirus debts need not be paid back at all.

First, even a higher debt-to-GDP ratio need not mean a greater burden of debt service when interest rates are falling. Inflation is falling everywhere, suggesting central banks may loosen financing conditions even further. As if on cue, the UK government’s three-year borrowing rate has gone negative for the first time.

Second, these low rates can be relied on for the long run. As a new IPPR paper argues, even much higher ratios of public debt to GDP are manageable because ultra-low interest rates can be locked in for a long time. That, of course, requires government debt managers to actually take the opportunity to radically extend the maturity of the debt they issue and remove any vulnerability to sudden rises in interest rates.

In other words, while public debt-to-GDP ratios will jump, the best policy may just be to live with the new level and not to go to any particular effort to reduce it. That, of course, presupposes that annual deficits come down enough to stabilise, if not reduce, the debt.

That leads to a third consideration. The best way to contain both deficits and debts is strong growth, and growth can itself be a victim of fiscal belt-tightening. It is now incontrovertible that in the eurozone, excessive fiscal consolidation in the past decade made the debt burden worse because it reduced growth, both by taking demand out of the economy and by having microeconomic effects that permanently damaged its productivity potential.

Conversely, there is good reason to think productive capacity responds positively to demand pressures. A great danger to a growth-promoting policy after the lockdown is the strange but all too common combination of two technocratic assumptions: that a period of poor growth indicates a lower potential output (requiring greater budget squeezes) — the so-called “scarring” many now worry about — and at the same time that “running the economy hot” with aggressive demand stimulus cannot push up the potential.

In the last recovery, worries about inflation that never emerged made macroeconomic policymakers more timid in stimulating demand than they needed to be. It would be terrible if they made a similar mistake today, fearing more scarring than there is solid evidence for.

One last consideration. The prospect of very high public debt stocks has brought into the mainstream an alternative to paying it back that was, until now, seen as radical and eccentric. I am talking, of course, of monetary financing or “helicopter money” to governments: having the central bank print money to finance the deficits. As a sign of how this is now considered a serious policy option, note how Nick Boles, a former Conservative MP, endorses it.

Monetising public debts can refer to many things. In a modest sense, it has already happened insofar as central banks are issuing reserves to buy up government bonds and will do so in similar quantities to the new issuance this year. In the most radical sense, monetary finance would mean the central bank simply cancelling the government debt it holds, or equivalently, keeping sovereign yields low forever even if that caused inflation.

The Rebuilding Macroeconomics project recently hosted a workshop on monetary financing and helicopter money where both my colleague Martin Wolf and I participated, which you can watch here. But a good short guide to these questions is a succinct piece by Olivier Blanchard and Jean Pisani-Ferry, who explain that the inflationary effects of monetary financing of governments really comes down to expectations of what the central bank will do with its reserve policies in the future.

The risk of inflation, they show, comes down to whether central banks will be tempted in future to keep interest rates on reserves near zero even when inflation pressures mean they should be increased. They think this is unlikely. I would go further: central banks have learnt how to “tier” reserves so they can pay interest rates on the margin — thus controlling inflationary pressures — but not on the bulk of reserves.

That blunts any dilemma between inflation control and government debt sustainability — and only reinforces Blanchard and Pisani-Ferry’s view that there is no reason to panic about debt monetisation, in the eurozone or elsewhere. Which, in turn, reinforces the broader case for not panicking about high public debt and denying the economy the stimulus it will continue to need for a long time.

Coronanomics readables

  • War is a misplaced metaphor for the effort to combat a pandemic, says my colleague John Paul Rathbone in a clever FT column: the better comparison is with crime-fighting.

  • The leaders of France and Germany raised hopes of a meaningful joint fiscal push for the EU’s economic recovery with their proposal for a €500bn grant programme financed by common debt issuance. Meanwhile, high-debt eurozone countries that have demanded joint borrowing are not taking yes for an answer: a virtually unconditional credit line has now been established at the bloc’s rescue fund but nobody wants to use it.

  • Monica de Bolle, of the Peterson Institute for International Economics, argues that developing countries could see the Covid-19 crisis as a moment to introduce universal basic income.

Other readables

  • The UK has set out its new tariff schedule to come into force at the expiration of the Brexit transition period, which is scheduled for the end of the year.

  • There is now a live e-coin tracker, where you can see at a glance how far different countries have gone down the path towards a central bank digital currency, courtesy of the Atlantic Council and Harvard University.

Numbers news

  • Germany’s Bundesbank sees signs that the German economy is beginning to recover.

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