IMF Changes its Tune on Austerity

Developed Governments Can Finance Expansionary Fiscal Policy After All

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A rare glimpse inside the research offices at the IMF

What a difference a decade makes. After an unnecessarily prolonged recovery from the Great Recession, the International Monetary Fund reversed itself a few years ago on the topic of fiscal expansion, or government spending in the political parlance. It had originally counseled austerity to plug the holes in sovereign balance sheets with reduced government expenditure, even though this flew in the face of eighty years of macroeconomic research.

We are constantly at risk of overlearning the lessons of the past, and so it was that hyperinflation concerns from the 1970s overwhelmed legitimate arguments for governments--especially Northern European ones--to hold the line on government spending. This had dreadful consequences, not only for the commonweal that financially suffered due to the protracted economic recover, but also for the fuel it added to the fire of economic dissatisfaction and perceived official indifference that culminated in the recent resuscitation of right-wing populism.

Better late than never, the IMF's Fiscal Monitor publication for 2020 now opines that developed economy governments should pursue responsible policies of fiscal expansion, as they enjoy record-low interest rates with which to fund them. As any business owner--but not, apparently, any corporate CEO--would be able to tell you, if you have the ability to generate a rate of return through capital investment that exceeds the cost of borrowing, then you should borrow until the cost of borrowing exceeds the return on investment, or until the debt-to-equity ratio exceeds that level which triggers financial distress.

The price to borrow for developed governments is currently so low that investors are paying for the privilege of holding government debt. This would indicate that the world faces an insufficient supply of debt to clear market demand at an efficient price. Therefore, developed governments should issue more debt and make productive capital investments in their economies. This would have the effect not only of boosting productivity at the time that the private sector has shown no appetite for risk, but of increasing the economy's ability to repay that debt in future. It's such a self-evident policy, even the IMF has gotten it right.

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