Effective Fiscal-Monetary Interactions in Severe Recessions

EffectiveFiscal-MonetaryInteractionsinSevereRecessions byJiaqianChen,RaphaelEspinoza,CarlosGoncalves,TryggviGudmundsson,MartinaHengge,ZoltanMatyasJakab,andJesperLinde WP/22/170 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate. TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. 2022 SEP ©2022InternationalMonetaryFundWP/22/170 IMFWorkingPaper FiscalAffairs,MonetaryandCapitalMarketandStrategy,PolicyandReviewDepartment EffectiveFiscal-MonetaryInteractionsinSevereRecessions PreparedbyJiaqianChen,RaphaelEspinoza,CarlosGoncalves,TryggviGudmundsson,MartinaHengge,ZoltanMatyasJakab,andJesperLinde* AuthorizedfordistributionbyStephanDanninger,JesperLindeandPauloMedas September2022 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. ABSTRACT:TheCOVID-19pandemicandthesubsequentneedforpolicysupporthavecalledthetraditionalseparationbetweenfiscalandmonetarypoliciesintoquestion.BasedonsimulationsofanopeneconomyDSGEmodelcalibratedtoemergingandadvanceeconomiesandcasestudyevidence,theanalysisshowswhenconstraintsarebindingamoreintegratedapproachoflookingatpoliciescanleadtoabetterpolicymixandultimatelybettermacroeconomicoutcomesundercertaincircumstances.Nonetheless,suchanapproachentailsrisks,necessitatingaclearassessmentofeachcountry’scircumstancesaswellassafeguardstoprotectthecredibilityoftheexistinginstitutionalframework. JELClassificationNumbers: E52;E58;E60;E62 Keywords: PolicyCoordination;Monetaryfinancing;FiscalDominance;PolicyMix;CentralBankIndependence Author’sE-MailAddress: jchen@imf.org;respinoza@imf.org;cgoncalves@imf.org;tgudmundsson@imf.org;mhengge@imf.org;jlinde@imf.org;zjakab@imf.org *TheauthorsaregratefultoRupaDuttaguptaandChristopherErcegfortheirguidanceontheproject.Wearealso indebtedtoStephanDanninger,PaoloMauro,PauloMedas,andSanjayaPanthforveryhelpfulfeedback.WewouldliketothankseminarparticipantsattheIMFforusefulcomments.ValentinaBonifacioandKailiChenprovidedexcellentresearchassistance. WORKINGPAPERS EffectiveFiscal-MonetaryInteractionsinSevereRecessions PreparedbyJiaqianChen,RaphaelEspinoza,CarlosGoncalves,TryggviGudmundsson,MartinaHengge,ZoltanMatyasJakab,andJesperLinde 3 Contents I.Introduction5 II.Context–limitedpolicyspaceandlowdemand8 III.Thedynamicsofcloserinteraction9 IV.Country-SpecificConsiderations–CaseStudies20 V.Conclusions30 FIGURES 1.NumberofCountriesConstrainedbyZLB5 2.ASevereRecessionScenario12 3.Whatcanmonetarypolicydoalonetofighttherecession14 4.Transientgovernmentspendinghikeof1percentofbaselineGDPfortwoyears16 5.Transientgovernmentspendinghikeinliquiditytrapunderalternativemonetary17 6.MonetaryandfiscalstimulusattheELBwithelevatedspreads19 7.Impactofthepandemiconoutputandinflation23 8.PublicdebtandassetpurchasesinBelgiumandpeercountries.24 9.PublicdebtandmonetarypolicyrateinBotswanaandpeercountries.24 10.PublicdebtandmonetarypolicyrateinIcelandandpeercountries.26 11.PublicdebtandmonetarypolicyrateinSouthAfricaandpeercountries.27 12.PublicdebtandmonetarypolicyrateinThailandandpeercountries.29 TABLE 1.Overviewoffindingsfromgeneralconsiderationsreflectingmodelimplications29 APPENDICES A.TheOpenEconomyDSGEModel35 B.1.RobustnesswithrespecttoinitialAITgap46 REFERENCES32 I.INTRODUCTION TheCOVIDcrisishittheglobaleconomyhardandnecessitatedanunprecedentedpolicyresponse.Theglobaleconomyshrunksharplyin2020,withoutput3percentbelowthe2019levelandactivityin consumer-facingservicessufferingparticularlylargedeclines.Inadditiontohealthmeasures,policymakersrespondedaggressivelyandcreativelytocushiontheblowtotherealeconomy,notablybyeasingfiscalpolicyandmonetarypolicy.Globally,fiscalmeasurestosupporttheeconomysummedtoUS$16.9trillion(IMF2021).Themostfar-reachingresponseoccurredinadvancedeconomies(AEs).Inadditiontotraditionalspendingandrevenuemeasures,variouslendingandloanguaranteeprogramsweredeployedtohelpweathertheshock.LeadingcentralbanksalsobroughtthepolicyratesclosertotheEffectiveLowerBounds(ELB)andagrowingnumberofthemstartedengagingin,oraddedtopreexisting,assetpurchaseprograms. Thecurrentnear-termoutlookishighlyuncertaindespiteanunderlyingongoingglobalrecovery.Whilepolicyhasstartedtotighteninmanycountriesalongsidethepickupingrowthandinflation,thewarinUkraineandlimitedpolicyspacearecomplicatingtheappropriatepolicysetting.Furthermore,thevaryingseverityofthehealthcrisis,coupledwithunequalinitialconditionsanddiversepolicyresponses,hasledtodivergingrecoveriesacrossregionsandincomelevels.Inadditiontotheunevennessoftherecoveryacrosscountries,thepathoutofthepandemichasbeenfurthercomplicatedbythesoaringcommodityprices,elevatedgeopoliticalrisk,andsupplydisruptionsrelatedtothewar. Policysupportthusremainsessentialinmanyeconomiestoensureabroad-basedrobustrecoverythatminimizeslong-te