Weakening growth and policy uncertainties cast a shadow over the fiscal outlook, even as budget deficits narrow and recent announcements by monetary authorities provide some respite on the financial front. Countries with stronger fiscal positions and lower public debt, including several emerging market economies, can afford to pause fiscal consolidation efforts, but in others adjustment must proceed at a pace that reflects medium-term adjustment needs, the state of the economy, and financing constraints. Where financing permits, flexibility should be allowed for automatic stabilizers to play in response to moderate growth shortfalls. Should growth fall well short of current expectations, countries with space should smooth their adjustment paths over 2013 and beyond. The United States and Japan must promptly define and enact clear and credible plans to return to fiscal sustainability over the medium term and buttress investor confidence.
Consolidation efforts are yielding fruit, at least for deficits. In 2013, cyclically adjusted deficits are expected to fall below their precrisis levels in about half of the countries included in the Fiscal Monitor database.2 The evolution of debt ratios is more varied: they have declined in most emerging market economies, but not in most of the advanced economies, reflecting in many cases higher interest rate–growth differentials in the latter group. Consolidation packages have typically attempted to focus on measures that are supportive of potential growth, but countries with large adjustment requirements have had to use a broader brush, in many cases cutting public investment and raising income taxes. Institutional reforms have also been introduced to strengthen governance and credibility, including—but not only—in the euro area.
Notwithstanding the progress mentioned in the preceding section, large financing requirements remain a source of near-term fiscal vulnerability in several advanced economies, while prospective increases in age-related spending loom large over the long-term horizon for many of them. Moreover, fiscal risks around the baseline projections are on the rise across country groups, given the uncertain growth outlook and large contingent liabilities, particularly from the financial sector.19 If history is a lesson, the path to restoring fiscal sustainability will be long and arduous for most advanced economies. Maintaining adjustment efforts over the long term will require packages that mesh flexibility and credibility (through the use of structural or cyclically adjusted targets), limit adverse social effects, and boost employment and labor supply through appropriate tax and other spending policies, backed by strong fiscal institutions.
The Great Recession of 2007–09 led to an unprecedented increase in public debt and raised serious, ongoing concerns about fiscal sustainability.33 Against this backdrop, many governments have been making substantial fiscal adjustments to reduce their ratios of debt to GDP. It is generally recognized that consolidation is bad for growth in the short run. But do different forms of fiscal consolidation affect income inequality as opposed to income levels?34 Surprisingly, there has been little systematic analysis of this question.35
Notwithstanding the deceleration in global activity in late 2011 and weaker growth prospects (see the April 2012 World Economic Outlook), fiscal deficits in most advanced economies are projected to continue to decline in 2012 (Table 1). Headline deficits will fall by almost 1 percentage point of GDP among the advanced economies, as countries unwind fiscal stimulus and, in a few cases, implement austerity measures in response to market pressures. At about 1 percentage point of GDP, deficit reduction in cyclically adjusted terms would be slightly higher than that implemented in 2011. In many cases, the challenge will be to ensure continued progress toward sound public finances while avoiding an excessive fiscal drag on activity. Gross financing needs are expected to decline only slightly, hovering around 25 percent of GDP per year over the coming three years in advanced economies, as lower deficits are offset by higher rollover requirements on a larger maturing debt stock (Table 2).
The COVID-19 pandemic has struck amid a preexisting sluggish global growth outlook, historically low nominal interest rates, and low inflation. The pandemic has elevated the need for fiscal policy action to an unprecedented level. For some countries, however, high debt levels and tightening financing conditions are constraining the policy response. But whereas in other economic downturns a key goal of fiscal policy is to stimulate demand, this crisis is like no other—and in its early stages the primary objectives are to boost resources for health care and to provide emergency lifelines to people and firms.
Fiscal efforts over the last five years have stabilized the average government debt-to-GDP ratio, albeit at a high level. Immediate pressures on public finances have eased with lower interest rates, but historically high debt ratios and a vacillating recovery, combined with looming pension and health costs, keep risks elevated.
This report overviews countries fiscal actions in response to COVID-19 and discusses how governments policies should adapt to get ahead of the pandemic and set the stage for a greener, fairer, and more durable recovery. Global vaccination should be scaled up as it can save lives and will eventually pay for itself with stronger employment and economic activity. Until the pandemic is brought under control globally, fiscal policies must remain flexible and supportive, while keeping debt at a manageable level over the long term. Governments also need to adopt comprehensive policies, embedded in medium-term frameworks, to tackle inequalities—especially in access to basic public services—that were exacerbated by the COVID-19 pandemic and may cause income gaps to persist. Investing in education, healthcare and early childhood development and strengthening social safety nets financed through improved tax capacity and higher progressivity, can strengthen lifetime opportunities, improve trust, and contribute to more social cohesion.