Davos 2023: How can governments use fiscal expansion as a tool?

The newly launched Chief Economists Outlook from the World Economic Forum finds that growth prospects remain anaemic, and the risk of a global recession is high.

With the looming economic storms, a panel at the Forum's Annual Meeting 2023 focused the discussion on fiscal expansion. Moderated by Stephanie Flanders, the Head of Economics and Government at Bloomberg LP, the speakers included Raghuram G. Rajan, Katherine Dusak Miller Distinguished Service Professor of Finance at the University of Chicago Booth School of Business; Gita Gopinath, First Deputy Managing Director of the International Monetary Fund (IMF); Paolo Gentiloni, Commissioner for Economy at the European Commission; and Arkhom Termpittayapaisith, Minister of Finance at the Ministry of Finance of Thailand.

Flanders started by asking: "How do you see the trade-off between monetary and fiscal policy today?" Gopinath at the IMF responded first: "We are in a unique time because of inflation. We have the kinds of inflations that we have never seen, it's coming down, but it's still high. That is what is generating the tension between monetary policy and fiscal policy..."

"You have an inflation problem to deal with, but you are still hit with shocks, like food shocks and energy shocks, that require fiscal policies to stand up. That is what is making the current conjuncture difficult."

What is important to keep in mind is inflation has helped a little bit on the debt story. If you look at what happened to the public sector debt globally in 2020, it went up to around 99% of GDP. Now it has come down to around 91% of the GDP. That is because of a combination of the recovery and also because of inflation inflating away some of that debt."

"In terms of what countries need to do to manage this difficult trade-off right now, I will say fiscal policy has to accomplish three things. One, it should be consistent with bringing inflation down, which means, at the minimum, it should not be expansionary. The second thing that fiscal policy should keep in mind is that you need to protect the most vulnerable, and they need to do that again when it comes to food and energy. These are fundamental essentials for households. You need to provide support for that."

"And, the last thing is, it is essential to communicate a sound fiscal framework and clarity on bringing down debt," Gopinath added.

Thailand takes a cautionary approach to its fiscal and monetary policy, says Termpittayapaisith at Thailand's Ministry of Finance. "During the pandemic, our monetary and fiscal policies worked closely together. We borrowed 1.5 trillion Thai Baht, but actually, that wasn't the biggest borrowing in the world because we looked carefully at how we could repay the debt in the future."

"So at the same time, we lifted the debt ceiling to give more fiscal space to the government, from 50% of GDP to 70%. So our debt performance, by our definition, is 60%, which is still in line with the ceiling, but by definition, our public debt is only 55%, which really isn't high."

"Now after two years, it's not only the monetary policy that needs to do more work, but the fiscal policy needs to become normalised as well. We need to look at how we pay back the debt," Termpittayapaisith says.

"There are two things to consider: firstly, whether the government will keep spending. I think this is important because in Thailand, there is a backlog of capital investment, particularly for infrastructure. So we have set 20% of our national budget for capital expenditure. So the fiscal policy in terms of the budget policy is expansion, but the thing is, we have to minimise our deficit because we have been running a deficit for almost 20 years. It is time now to put our budget deficit down to below 3%."

Termpittayapaisith also spoke about how they are addressing these challenges. "How do we do that? On one side, revenue collection is important. We have to expand our taxes," he says.

"Right now, we are not able to talk about personal income tax because it's very low already. Corporate income tax is low too, but we can expand the digital tax. Electronic service, for example. Getting more people and more start-ups into the system. So that is what we are doing right now."

It is crucial that fiscal policy is not forced to compete with monetary policy, agrees the European Commission's Paolo Gentiloni. However, he conceded this is easier said than done.

"There are two challenges now, in my view, if we want good coordination between monetary and fiscal policy. The first is how we are able to avoid expenditure," he says.

"The second challenge is we need to keep a good level of public investment in strategic areas. This is what, for me, is very encouraging. Looking at the budget that we have for 2023, public investment is not decreasing, it is increasing. It is exactly the opposite of what happened after the financial crisis when we had five or six years of continuously decreasing public investments."

Flanders then asked Raghuram G. Rajan at the University of Chicago Booth School of Business, how he believed fiscal policymakers should be thinking about using fiscal policy as a tool. To answer this question, Rajan first suggested looking at why spending was so easy. "Part of that is because the central banks had anaesthetised bonds. The problem is some of it was hidden. What central banks were doing is buying long-term debt and financing it with overnight money. When you put the balance sheet of the central bank together with the government balance sheet, what it means is governments have reduced the maturity of their debt," he says.

"So high-interest rates hit harder earlier in many countries. Of course, the other problem is the size of the debt has gone up tremendously over the last few years, and that is actually an interesting issue. Why has fiscal discipline broken down? Spending today is highly untargeted."