The world economy is currently facing an acute shortage in demand due to the lockdown imposed to contain the spread of COVID-19. Most of the economies are projected to register a negative growth rate and unemployment rates are set to skyrocket. This would further reduce the aggregate demand, pushing economies into a vicious trap of decline in demand leading to lower profits and investment, which in turn would further curtail growth and aggravate unemployment. Rising unemployment and falling wages would further depress the levels of demand in the economy. To get out of this vicious cycle, economies require a big push aimed at reviving aggregate demand. With little hope for export-led growth, given the global nature of the pandemic, governments have to boost their economies by reviving domestic demand through large fiscal stimulus.
Most governments, however, are clueless about how to finance such a big push in the face of falling revenue receipts. One way out of the problem is to frontload government expenditures financed by temporary monetization at the discounted interest rate. The government exchequer should not be compared with the financing of household expenditures as the government owns the central bank that can print (create) money. Monetized deficit would not lead to an inflationary situation under a depression caused by lack of aggregate demand.
It is important to note that there is another vicious cycle of public finance. Lower purchasing power and consumption demand would mean lower indirect tax collections. The direct tax collections, too, would be lower given falling income and profit levels as a result of the COVID-19 lockdown. There would be a sizable decline, therefore, in the revenue receipts of the government. Expenditure needs, however, would have increased given mounting healthcare requirements and the need to compensate the poor and vulnerable for their income loss. Lower revenue and increased expenditure would mean a larger fiscal deficit. Given low growth rates, fiscal deficit as a proportion of GDP would rise as well. If the economy takes a long time to revive, the future stream of revenue receipts would also be lower, thereby further curtailing the fiscal space to boost aggregate demand. As a result, the fiscal deficit and public debt to GDP ratio would continue to spiral downward.
The way out is for governments of independent nation-states to borrow for the time being from their own central banks and spend liberally. This would revive aggregate demand, reduce the unemployment rate, protect wage and profit rates, and boost the future stream of government revenue receipts. Hopes and future expectations, the driving force of capitalism, would reach normal levels again. There is a dire need, therefore, to frontload the entire planned expenditure of the next 4-5 years and incur those expenditures now within a year or two to give the economy a big demand side push. The governments may reduce the degree of monetization gradually as the aggregate demand revives and the future revenue receipts pick up. If the growth rate revives, the fiscal deficit as a proportion of GDP would come down automatically.
If governments follow this strategy, the fiscal deficit would go up temporarily, but the future would be more promising and there would be less economic distress for the people. If they do not give the big demand push now, the humanitarian crisis would worsen and the fiscal space shrink even further in the days to come. In fact, many governments have responded to the crisis in a fiscally conservative manner and have made expenditure cuts into other sectors in order to spend some more money on health and to compensate for the falling revenue receipts. However, this is not the time for fiscal conservatism. The law and order situation may go out of control in parts of the world because of the sudden rise in unemployment. Therefore, it is better to boost the economy now through well-designed fiscal stimulus packages by taking short-term loans from the central banks (at discounted rates) of the respective independent nation-states. Otherwise, we shall fall into the obvious vicious traps.
Many countries have announced various stimulus packages. While such steps are welcome, most of them are indirect monetary and financial measures rather than fiscal stimulus which can enhance the purchasing power of people more directly. For example, while lowering interest rates to encourage investors to take credit on easier terms and lowering the reserve ratios to inject liquidity into the banking system may potentially boost investment to some extent, aggregate investment would depend on the expected rate of net profit, which is primarily demand determined. If business sentiments are low and the market is down, aggregate credit offtake would remain low and it would not have any stimulating effect on the economy as a whole. Some compensations have been given to the poor through direct benefit transfers, and free food and medical facilities, but that is very small as compared to the income loss of people in the entire economy. Therefore, there would be a net loss of purchasing power at the aggregate level.
Some are of the opinion that the recovery will be automatic – the government does not have to play any proactive role in boosting the economy. There would definitely be some recovery as compared to the lockdown period, but the level of activity cannot become higher than the same period last year, following the lockdown and huge loss of purchasing power of people, automatically, without any fiscal stimulus. Also, fiscal stimulus in the form of tax-cuts would be far less effective than expenditure expansion that can enhance the purchasing power of the common people and the poor. The multiplier impact of the same amount of fiscal stimulus on the aggregate demand would be much higher for pro-poor government expenditure because of the higher consumption propensity of the poor as compared to the rich. Governments need to take some bold measures such as last resort employment programs at minimum wages, quality universal healthcare facilities at affordable rates, universal food security programs and free education for all in the current situation. Larger public spending on social sectors would reduce peoples’ out of pocket expenditure and enhance their purchasing power which, in turn, would help solve the aggregate demand problem. If aggregate private investment is insufficient for absorbing the existing labor-force in the country, public sector investment has to fill the gap to ensure a near full-employment situation in the near future.
As and when the fiscal deficit to GDP ratio reduces after revival, central banks could sell the government bonds to commercial banks, other financial institutions, and the public, provided there is demand for them, to reduce the monetized deficit as a proportion of GDP. As the GDP grows, fiscal deficit and public debt as a proportion of GDP would automatically come down. Interest payment on the increased government borrowing would not put additional pressure on future generations because the future level of activity would be higher and the future unemployment rate lower. Short-run profit driven policy direction in the current juncture may cause great harm to humanity – in the absence of a big push, the world economy would take a long time to come back to the business as usual level of activity. Incumbent governments would lose popularity and billions of people would suffer across the globe. Pursuing fiscal conservatism in today’s situation would be a historic blunder. A big demand boost by frontloading the government spending is absolutely essential to ensure at least the ‘business as usual’ scenario. There must be proper planning of the revival policy – demand-side economists must be given a patient hearing.