The Global Pandemic, Policy Space and Fiscal Rules to Achieve Stronger Stabilization Policies

Seoul Journal of Economics, Vol. 33, No. 3, 2020

26 Pages Posted: 3 Sep 2020

See all articles by Michael M. Hutchison

Michael M. Hutchison

University of California, Santa Cruz - Department of Economics

Date Written: August 30, 2020

Abstract

The world economy was slowing prior to the onset of the Covid-19 pandemic. The slowdown began after a record-long period of expansion marked with record lows in unemployment and strong economic indicators along most dimensions. Even at a high point of the business cycle, however, “depression style” economic policies of very low or zero policy interest rates and large budget deficits were being followed in many countries—partly due to the lingering effects of the Great Recession and partly due the long-standing problem of “deficit bias” in fiscal policy. Fiscal responses to the Covid-19 shock in the form of wage support, business loans and other programs in 2020 were substantial and necessary but, following already large fiscal deficits and growing government debt, have aggravated the problem of long-term fiscal solvency. In some cases, concerns over record peacetime budget deficits constrained government’s willingness to pursue further rounds of fiscal stimulus as the Covid-19 crisis deepened. This article argues that deficit bias constrained discretionary fiscal policy actions arises from political economy factors and demonstrates that fiscal rules are an important instrument to mitigate deficit bias and restore countries to longer-term solvency. Countries with strong fiscal rules had much better fiscal and debt positions prior to the Great Financial Crisis, allowing them in turn to pursue much more stimulative fiscal policies in response to the crisis. The same situation faced policy makers at the onset of the pandemic economic crisis-- those with strong fiscal rules were in a much better position to provide large fiscal responses to support the economy without endangering national debt solvency. Facilitating long-term fiscal solvency and allowing for larger discretionary fiscal actions in crisis situations provides a strong argument for the strengthening and enforcement of fiscal rules around the world.

Keywords: Pandemic, Fiscal rules, Stabilization policy

JEL Classification: E32, E62, H5

Suggested Citation

Hutchison, Michael M., The Global Pandemic, Policy Space and Fiscal Rules to Achieve Stronger Stabilization Policies (August 30, 2020). Seoul Journal of Economics, Vol. 33, No. 3, 2020 , Available at SSRN: https://ssrn.com/abstract=3685018

Michael M. Hutchison (Contact Author)

University of California, Santa Cruz - Department of Economics ( email )

Social Sciences I
Santa Cruz, CA 95064
United States
831-459-2600 (Phone)
831-459-5900 (Fax)

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