Publication - USING THE FISCAL LEVERS TO ESCAPE THE LOW-GROWTH TRAP
© 2016 Organisation for EconomicCo-operation and Development
Almost a decade after the outbreak of the financial crisis, the global economy remains in a low-growth trap with weak investment, trade, productivity and wage growth and rising inequality in some countries.
Monetary policy is overburdened, leading to growing financial risks and distortions. Alongside structural reforms, a stronger fiscal policy response is needed to boost near-term growth and strengthen long-term prospects for inclusive growth.
However, in the context where public debt has reached high levels in most OECD countries, it is important to assess the extent of countries' fiscal space and the temporary deficit increase they can afford to run. In the past few years, the assessment of fiscal policy has focused essentially on public budget balance positions rather than on the consequences for growth. This focus has resulted in a higher debt-to-GDP ratio in the short term through shortfalls in investment, human capital and productivity. A rethink is needed for how the fiscal policy stance should be evaluated, particularly in the context where very low sovereign interest rates provide more fiscal space. In order to escape the low-growth trap, this chapter emphasises the need for a fiscal initiative, comprising of spending or tax measures, to foster productivity in the medium to long term. Measures should be chosen depending on each country's most pressing needs and could include not only raising soft and hard infrastructure or education spending, but also cutting harmful taxes. In many countries, such a package could be deficit-financed for a few years, before turning budget-neutral. Combining this initiative with structural reforms will enhance the output gains.
The main messages from re-evaluation in this chapter are the following:
Fiscal space has increased
● Interest rates on government debt are very low in advanced economies, following exceptional monetary stimulus, and borrowing costs are also relatively favourable in many emerging market economies (EMEs).
● Measures of fiscal space – those that focus on the gap between actual debt and estimated levels at which market access would be compromised – appear to have risen in most OECD countries since 2014, as lower interest rates have more than offset headwinds from lower potential growth and higher debt.
● Other measures that account for projected long-term ageing-related spending pressures also point to some fiscal space in most of the larger advanced economies.This provides room for manoeuvre, provided that low interest rates are locked-in with long-term borrowing.
● Structural reforms that aim at containing the cost of healthcare and pension spending, including by reforming entitlements, can create additional space. Governments can also increase fiscal space with policies raising long-term growth, for instance by changing the composition of taxes and spending.
A fiscal initiative would support long-term growth
● OECD governments could finance a ½ percentage point of GDP productivity-enhancing fiscal initiative, for three to four years on average in OECD countries without raising the debt-to-GDP ratio in the medium term, provided the selected activities and projects are sound. Such an initiative could encompass high-quality spending on education, health and research and development as well as green infrastructure that all bring significant output gains in the long run.
❖ In the current economic environment and with monetary policy unchanged, the average output gains for the large advanced economies of such a fiscal initiative amount to 0.4-0.6% in the first year. However, the gains are particularly uncertain for Japan.
❖ Pursuing the fiscal initiative by reprioritising spending in later years would increase long-run output by up to 2% in the large advanced economies. Its impact could be enhanced under certain conditions
● Complementing fiscal action with structural reforms is crucial to get the most out of the stimulus. ● Persistent demand weakness, which gradually undermines the productive capacity of the economy (“hysteresis”), reinforces the case for a fiscal initiative in Italy and France and in a number of smaller Southern European economies with wide negative output gaps.
● Collective fiscal action among the large advanced economies is estimated to bring additional output gains of about 0.2 percentage point on average after one year (through international trade linkages), compared with a scenario where countries act individually. The fiscal initiative should be adapted to national circumstances
● The increased fiscal space should be used efficiently and country specificities, in particular their fiscal situation, cyclical position and other features, such as the extent of investment needs in soft or hard infrastructure or other priorities, need to be accounted for.
❖ In about a third of the countries covered in the Economic Outlook, the OECD recommends more expansionary fiscal policy than currently planned.
❖ With the fiscal stance in advanced economies expected to be broadly neutral in 2017 according to current fiscal plans, a number of large economies, including Germany, should borrow more than currently envisaged to raise public investment. A fiscal initiative in the United Kingdom would help to manage the contractionary impact of Brexit. In a few countries like Japan, however, a productivity-enhancing fiscal initiative should be budget-neutral.
❖ Ample but narrowing fiscal space gives China room to run an expansionary fiscal policy, but less so than currently planned by the government. It should be directed at increasing social safety nets rather than already high infrastructure spending, which would tend to reduce precautionary household saving and thus achieve the same objective of higher demand and supply. India can regain fiscal room for manoeuvre with an increase in tax revenues and an improvement in spending efficiency.
● In all the countries covered, taxes and spending should be reprioritised and move towards a mix that fosters long-term growth and inclusiveness, including by restoring public investment and other productive spending that was cut in the recent past.
● In all the countries covered, taxes and spending should be reprioritised and move towards a mix that fosters long-term growth and inclusiveness, including by restoring public investment and other productive spending that was cut in the recent past.
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