April 20th, 2015
from the International Monetary Fund
A moderate and uneven recovery is taking place in advanced economies, supported by lower oil prices, continued accommodative monetary policy, and slower fiscal adjustment. However, high public and private debt levels continue to pose headwinds to growth and debt sustainability in some advanced economies. In addition, inflation is below target by a large margin in many countries, making the task of reducing high public debt levels more difficult. Growth in emerging economies is softening and financial and exchange rate volatility has increased public financing costs for some of them. Meanwhile, lower oil and commodity revenues have created challenges for exporting countries.
In this challenging environment, fiscal policy continues to play an essential role - alongside accommodative monetary policy and structural reforms - in building confidence and, where appropriate, sustaining aggregate demand. With narrow margins for policy maneuvering, three courses of action for sound fiscal policy stand out:
Use fiscal policy flexibly to support growth, while mitigating risks and ensuring medium-term debt sustainability. The degree and type of flexibility will depend on individual countries' fiscal positions, macroeconomic conditions, and relevant fiscal risks. Countries with fiscal space can use it to support growth, particularly where risks of low growth and low inflation have materialized. For example, higher public investment in infrastructure could raise aggregate demand in the short term and increase potential output in the medium term. Countries that are more constrained should pursue more growth-friendly fiscal rebalancing and structural reforms to boost potential growth. Meanwhile, in countries where mounting fiscal risks may lead to market pressure, rebuilding fiscal buffers should be a priority. In oil- and commodityexporting countries, the government's financial assets, if sufficient, can be used to adjust gradually to the shock from lower oil prices. Nonetheless, spending cuts may be unavoidable in some financially constrained oil exporters. In economies with oil subsidies, the windfall gains from lower prices should be used to increase spending that can boost growth and, where macroeconomic vulnerabilities are high, to rebuild fiscal buffers.
Seize the opportunity created by falling oil prices. Energy tax reform can help reduce negative externalities caused by energy consumption and provide breathing room for rebalancing the tax burden - for example, by lowering taxes on labor to boost employment. In developing economies, further reform of energy subsidies could provide space for productive spending on education, health, and infrastructure, as well as for programs to benefit the poor.
Strengthen institutional frameworks for managing fiscal policy. Fiscal frameworks anchor fiscal policy and guide it toward its medium-term objectives. These frameworks help enhance the play of automatic stabilizers over the course of the business cycle and thus reduce output volatility and raise medium-term growth. Well-grounded fiscal frameworks are particularly necessary in countries with high levels of public debt and a looming increase in the burden of agerelated spending.