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A Long, Uneven and Uncertain Ascent

2020-10-13T17:21:07-04:00October 13, 2020|

By Gita Gopinath

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The COVID-19 pandemic continues to spread with over 1 million lives tragically lost so far. Living with the novel coronavirus has been a challenge like no other, but the world is adapting. As a result of eased lockdowns and the rapid deployment of policy support at an unprecedented scale by central banks and governments around the world, the global economy is coming back from the depths of its collapse in the first half of this year. Employment has partially rebounded after having plummeted during the peak of the crisis.

This crisis is however far from over. Employment remains well below pre-pandemic levels and the labor market has become more polarized with low-income workers, youth, and women being harder hit. The poor are getting poorer with close to 90 million people expected to fall into extreme deprivation this year. The ascent out of this calamity is likely to be long, uneven, and highly uncertain. It is essential that fiscal and monetary policy support are not prematurely withdrawn, as best possible.

This is the worst crisis since the Great Depression, and it will take significant innovation on the policy front, at both the national and international levels to recover from this calamity.

In our latest World Economic Outlook, we continue to project a deep recession in 2020. Global growth is projected to be -4.4 percent, an upward revision of 0.8 percent compared to our June update. This upgrade owes to somewhat less dire outcomes in the second quarter, as well as signs of a stronger recovery in the third quarter, offset partly by downgrades in some emerging and developing economies. In 2021 growth is projected to rebound to 5.2 percent, -0.2 percent below our June projection.

Except for China, where output is expected to exceed 2019 levels this year, output in both advanced economies and emerging market and developing economies is projected to remain below 2019 levels even next year. Countries that rely more on contact-intensive services and oil exporters face weaker recoveries compared to manufacturing-led economies.

The divergence in income prospects between advanced economies and emerging and developing economies (excluding China) triggered by this pandemic is projected to worsen. We are upgrading our forecast for advanced economies for 2020 to -5.8 percent, followed by a rebound in growth to 3.9 percent in 2021. For emerging market and developing countries (excluding China) we have a downgrade with growth projected to be -5.7 percent in 2020 and then a recovery to 5 percent in 2021. With this, the cumulative growth in per capita income for emerging-market and developing economies (excluding China) over 2020–21 is projected to be lower than that for advanced economies.

This crisis will likely leave scars well into the medium term as labor markets take time to heal, investment is held back by uncertainty and balance sheet problems, and lost schooling impairs human capital. After the rebound in 2021, global growth is expected to gradually slow to about 3.5 percent into the medium term. The cumulative loss in output relative to the pre-pandemic projected path is projected to grow from 11 trillion over 2020–21 to 28 trillion over 2020–25. This represents a severe setback to the improvement in average living standards across all country groups.

There remains tremendous uncertainty around the outlook with both downside and upside risks. The virus is resurging with localized lockdowns being re-instituted. If this worsens and prospects for treatments and vaccines deteriorate, the toll on economic activity would be severe, and likely amplified by severe financial market turmoil. Growing restrictions on trade and investment and rising geopolitical uncertainty could harm the recovery. On the upside, faster and more widespread availability of tests, treatments, vaccines, and additional policy stimulus can significantly improve outcomes.

More Action is Needed

The considerable global fiscal support of close to $12 trillion and the extensive rate cuts, liquidity injections, and asset purchases by central banks helped saved lives and livelihoods and prevented a financial catastrophe.

There is still much that needs to be done to ensure a sustained recovery. First, greater international collaboration is needed to end this health crisis. Tremendous progress is being made in developing tests, treatments and vaccines, but only if countries work closely together will there be enough production and widespread distribution to all parts of the world. We estimate that if medical solutions can be made available faster and more widely relative to our baseline, it could lead to a cumulative increase in global income of almost $9 trillion by end-2025, raising incomes in all countries and reducing income divergence.

Second, to the extent possible, policies must aggressively focus on limiting persistent economic damage from this crisis. Governments should continue to provide income support through well targeted cash transfers, wage subsidies, and unemployment insurance. To prevent large scale bankruptcies and ensure workers can return to productive jobs, vulnerable but viable firms should continue to receive support—wherever possible—through tax deferrals, moratoria on debt service, and equity-like injections.

Over time, as the recovery strengthens, policies should shift to facilitating reallocation of workers from sectors likely to shrink on a long-term basis (travel) to growing sectors (e-commerce). Workers should be supported through this adjustment with income transfers, retraining, and reskilling. Supporting reallocation will also require steps to speed up bankruptcy procedures and resolution mechanisms to efficiently tackle firm insolvencies. A public green infrastructure investment push in times of low interest rates and high uncertainty can significantly increase jobs and accelerate the recovery, while also serving as an initial big step towards reducing carbon emissions.

Emerging market and developing economies are having to manage this crisis with fewer resources, as many are constrained by elevated debt and higher borrowing costs. These economies will need to prioritize critical spending for health and transfers to the poor and ensure maximum efficiency. They will also need continued support in the form of international grants and concessional financing, and debt relief in some cases. Where debt is unsustainable it should be restructured sooner than later to free up finances to deal with this crisis.

Lastly, policies should be designed with an eye toward placing economies on paths of stronger, equitable, and sustainable growth. The global easing of monetary policy, while essential for the recovery, should be complemented with measures to prevent build-up of financial risks over the medium term, and central bank independence should be safeguarded at all costs. Needed fiscal spending and the output collapse have driven global sovereign debt levels to a record 100 percent of global GDP. While low interest rates alongside the projected rebound in growth in 2021 will stabilize debt levels in many countries, all will benefit from a medium-term fiscal framework to give confidence that debt remains sustainable. In the future, governments will likely need to raise the progressivity of their taxes while ensuring that corporations pay their fair share of taxes, alongside eliminating wasteful spending.

Investments in health, digital infrastructure, green infrastructure, and education can help achieve productive, inclusive, and sustainable growth. And expanding the safety net where gaps exist can ensure the most vulnerable are protected while supporting near-term activity.

This is the worst crisis since the Great Depression, and it will take significant innovation on the policy front, at both the national and international levels to recover from this calamity. The challenges are daunting. But there are reasons to be hopeful. The exceptional policy response, including the establishment of the European Union pandemic recovery package fund and the use of digital technologies to deliver social assistance are a powerful reminder that well-designed policies protect people and collective economic wellbeing. At the IMF, we have provided funding at record speed to 81 members since the start of the pandemic, granted debt relief, and called for extended debt service suspension for low-income countries and for reform of the international debt architecture. Building on these actions, policies for the next stage of the crisis must seek lasting improvements in the global economy that create prosperous futures for all.


Finding the Right Policy Mix to Safeguard our Climate

2020-10-07T13:05:48-04:00October 7, 2020|

By IMF Staff

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Unaddressed, climate change will entail a potentially catastrophic human and economic toll, but it’s not too late to change course.

Global temperatures have increased by about 1°C since the pre-industrial era because of heat-trapping green-house gases accumulating in the atmosphere. Unless strong action is taken to curb emissions of these gases, global temperatures could increase by an additional 2–5°C by the end of this century. Keeping temperatures to levels deemed safe by scientists requires bringing net carbon emissions to zero on net globally by mid-century.

…economic policy tools can pave a road toward net zero emissions by 2050 even as the world seeks to recover from the COVID-19 crisis.

In the latest World Economic Outlook we make the case that economic policy tools can pave a road toward net zero emissions by 2050 even as the world seeks to recover from the COVID-19 crisis. We show that these policies can be pursued in a manner that supports economic growth, employment and income equality.

The manageable costs of mitigation

Economic policies can help address climate change through two main channels: by affecting the composition of energy (high- vs. low-emission sources), and by influencing total energy usage. The costs and benefits of different policies are determined by how they exploit these distinct channels.

For example, a carbon tax makes dirty fuels more expensive, which incentivizes energy consumers to shift their consumption towards greener fuels. Total energy consumption falls too because, overall, energy is more expensive.

In contrast, policies that aim to make green energy cheaper and more abundant (subsidies or direct public investment in green energy) increase the share of low-emissions energy. However, by making energy cheaper overall, green energy subsidies continue to stimulate total energy demand or at least do not reduce it.

In line with this intuition, our latest analysis suggests pairing carbon taxes with policies that cushion the impact on consumers’ energy costs can deliver rapid emissions reductions without major negative impacts on output and employment. Countries should initially opt for a green investment stimulus—investments in clean public transportation, smart electricity grids to incorporate renewables into power generation, and retrofitting buildings to make them more energy efficient.

This green infrastructure push will achieve two goals.

First, it will boost global GDP and employment in the initial years of the recovery from the COVID-19 crisis. Second, the green infrastructure will increase productivity in low-carbon sectors, thereby incentivizing the private sector to invest in them and making it easier to adapt to higher carbon prices. Our model-based scenario analysis suggests that a comprehensive policy strategy to mitigate climate change could boost global GDP in the first 15 years of the recovery by about 0.7 percent of global GDP on average, and employment for about half of that period leading to about 12 million extra persons being employed globally. As the recovery takes hold, preannounced and gradually rising carbon prices will become a powerful tool to deliver the needed reduction in carbon emissions.

If implemented, such a policy program would put the global economy on a sustainable path by reducing emissions and limiting climate change. The net effect would approximately halve the expected output loss from climate change and provide long-term, real GDP gains well above the current course from 2050 onward.

Transition costs

Despite the long-run benefits, and an initial boost to economic activity, such policies do impose costs along the transition. Between 2037–50, the mitigation strategy would hold global GDP down by about 0.7 percent on average each year and by 1.1 percent in 2050 relative to unchanged policies. These costs seem manageable, however, considering that global output is projected to grow by 120 percent between now and 2050. The drag on output could be further reduced if climate policies incentivize technological development in clean technologies—through R&D subsidies, for instance. Moreover, the package would be neutral for output during that period if important benefits in the form of better health outcomes (due to reduced pollution) or less traffic congestion are considered.

The transitional output costs associated with the policy package vary significantly across countries. Some of the advanced economies may experience smaller economic costs or even see gains throughout the transition. Given their earlier investments into renewables, these economies can more easily ramp up their use and avoid large adjustment costs. Countries with fast economic or population growth (India, especially) and most oil producers should expect larger economic costs by forgoing cheap forms of energy, such as coal or oil. Yet these output costs remain small for most countries and need to be weighed against avoided climate change damages and the health benefits from reducing the use of fossil fuels.

Reducing the burden

Low-income households are more likely to be hurt by carbon pricing, as they spend a relatively large share of their income on energy and are more likely to be employed in carbon-intensive manufacturing and transportation. Governments can use various policies to limit the adverse effects of higher carbon prices on households.

First, they can fully or partially rebate the carbon revenues through cash transfers. For example, our research found that to fully protect consumption of households in the bottom 40 percent of the income distribution, the U.S. government would need to transfer 55 percent of all carbon pricing revenues, whereas the Chinese government would need to transfer 40 percent.

Second, higher public spending—for instance on clean public infrastructure—could create new jobs in low-carbon sectors that are often relatively labor intensive to offset job losses in high-carbon sectors. Retooling workers will also help to smoothen job transitions to low-carbon sectors.

Governments should move swiftly to ensure a growth-friendly and just transition.

Based on Chapter 3 of the World Economic Outlook, “Mitigating Climate Change – Growth and Distribution-Friendly Strategies,” by Philip Barrett, Christian Bogmans, Benjamin Carton, Oya Celasun, Johannes Eugster, Florence Jaumotte, Adil Mohommad, Evgenia Pugacheva, Marina M. Tavares, and Simon Voigts.

Monetary Policy for all? Inequality and the Conduct of Monetary Policy

2020-10-02T10:55:54-04:00September 30, 2020|

By Niels-Jakob Hansen, Alessandro Lin, and Rui C. Mano

Inequality in both advanced economies and emerging markets has been on the rise in recent decades. The COVID-19 pandemic has exacerbated and raised awareness of disparities between the rich and poor.

Fiscal policies and structural reforms are long known to be powerful mitigators of inequality. But what role can the central bank play?

In new IMF staff research, we find a case for central bankers to take inequality specifically into account when conducting monetary policy.

A new view on monetary policy

Even though inequality remains outside central banks’ mandates, major central bankers are increasingly discussing distributional issues. At the same time, recent advances in economic theory shed new light on the interplay of monetary policy and inequality.

It is now accepted within academia and major central banks that wealth and income inequality affect the effectiveness of monetary policy. This is because the poor, who tend to be more liquidity constrained than the rich, increase their consumption more as their incomes rise in response to an interest rate cut. The same rate cut thus stimulates aggregate consumption more in an economy with a larger proportion of the poor. Relatedly, there is evidence supporting that monetary policy itself can affect inequality.

…we find a case for central bankers to take inequality specifically into account when conducting monetary policy.

Our research asks whether inequality affects the way monetary policy should be conducted in a stylized economy where business cycles are driven by innovations in technology. In this setting, a rich person—call her R—owns all the capital. R’s income is thus composed of after-tax dividends and wages. In contrast, a poor person—call her P—receives only wages and a transfer from the government financed by the dividend tax. In the model, profits and capital income rise in response to positive productivity shocks, thereby exacerbating inequality. Moreover, wages are tech-biased: when productivity rises, R’s share of total wage income goes up, while P’s declines. These mechanisms are consistent with U.S. micro- and macro-economic data and match the empirical effects of technology shocks on consumption inequality.

We study implications for monetary policy in two settings. In the first, the central bank chooses the best possible path of interest rates with full information and caring equally about all individuals. This setting is called “optimal policy.” In the second setting, the central bank sets monetary policy according to a so-called Taylor rule, which prescribes a given interest rate based on whether inflation and output deviate from desired levels. This second setting is useful because it is closer to what central banks do in practice. In our study, the relevant concept of inequality is the difference in consumption between rich and poor.

Implications for monetary policy

In the first setting, we find that a central bank should place some weight on observed consumption inequality. That means the central bank will use monetary policy, by setting lower interest rates that stimulate growth and wages and thereby reducing consumption inequality, while tolerating inflation moving above its target. However, we find that this weight is generally small and thus output and inflation are not that different from those that would prevail if the central bank ignored inequality. Interestingly, a central bank pursuing such “optimal policy” cares progressively less about inflation and more about growth the higher the initial level of inequality. This is because when initial inequality is high the central bank will try harder to adjust interest rates to stabilize wages and protect the consumption of the poor. Thus, stabilizing wages, and hence inequality, coincides with stabilizing growth.

In the second setting, we find that a central bank should pursue an augmented “Taylor rule” targeting also consumption inequality. That means following a positive productivity shock, interest rates should be set lower than the level implied by a standard Taylor rule that targets output and inflation alone. A policy of lower interest rates leads to higher wages which benefits the poor. Beyond lowering inequality, such a policy is also beneficial more generally because it improves inflation and growth outcomes by avoiding excessive tightening of the interest rate in response to a positive productivity shock.

These results suggest that welfare could be improved if central banks take inequality into account when conducting monetary policy, particularly if following typical interest rate rules. Our results of course are model specific and can be complemented by considering additional features, for example, by including differentiated types of labor and hence differentiated wages, or a richer set of available assets. The results bolster the case for more theoretical and empirical work on the issue.

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