The Whole Can Be Greater Than the Sum of its Parts

By Vitor Gaspar, Maurice Obstfeld and Ratna Sahay

There are policy options to bring new life into anemic economic recoveries and to counteract renewed slowdowns.  Our new paper, along with our co-authors, debunks widespread concerns that little can be done by policymakers facing a vicious cycle of (too) low growth, (too) low inflation, near-zero interest rates, and high debt levels.

What is the secret? There are three parts to it. None of them is new, but putting them together can add a punch to policy:

  • First, policies within countries must be comprehensive—this is not new. For the past two years, the IMF’s Managing Director Christine Lagarde has repeatedly championed the simultaneous use of three prongs: monetary; fiscal; and structural policies.
  • Second, policies within countries must be consistent over time—this view is also not new, but this paper illustrates its critical importance.
  • And third, there is a case for internationally coordinated policies. The IMF has long noted the potential benefits of policy coordination, but the paper illustrates how policies can become much more effective when countries work together toward a common goal.

Policies must be comprehensive

Too often, monetary policy has been the only game in town. Low interest rates since the global financial crisis have not brought growth back to acceptable levels. But monetary policy alone is not enough—fiscal and structural policies need to do much more.

For example, targeted public investment can raise domestic demand to close the output gap and, at the same time, raise potential output on a sustainable basis. Structural reforms of product and labor markets would also help unleash countries’ economic potential. Financial sector policies that strengthen banks and private balance sheets get credit flowing again, improve the impact and effectiveness of monetary policy, and build resilience of financial systems to shocks.

Importantly, these policies complement each other. By acting together, they will have a total effect greater than the sum of benefits from each policy acting alone. For instance, a temporary increase in public investment will have a much greater impact on real and nominal GDP if accompanied by monetary policy accommodation. Structural measures can be more effective with fiscal policy support.

Policies must be consistent

Expansionary monetary and fiscal policies are not likely to succeed if people believe that monetary tightening cannot happen without unsettling markets or that high debt levels will increase risk to intolerable levels. Rather, for accommodative macroeconomic policies to work, policymakers must commit to credible frameworks that adjust policy instruments consistently over time.

In the case of monetary policy, a temporary overshooting of the inflation target can help economies escape the deflationary trap much faster if a detailed, transparent, and well-communicated strategy shows the public that the monetary framework can safely allow for such deviations.

Similarly, a credible fiscal framework embeds a longer-term vision by indicating how short-term increases or changes in the composition of spending can actually help reduce government debt levels over time, and contain risks associated with public sector balance sheets.

Policies work better when coordinated across borders, especially if a shock strikes again

It would be in each country’s interest to coordinate their policies with other countries. By pulling in the same direction at the same time, they can amplify their domestic efforts to lift growth at home and, by implication, around the world. Such coordination between countries would be particularly valuable in the event of another shock like the one in 2008.

The benefits of global coordination are indeed recognized in the [2014] G20 Brisbane Action Plan, where major countries committed themselves to stimulate growth at home, using the tools at their disposal and operating within their own political and economic constraints.

Does this mean that all these elements have to be deployed at the same time? The answer is no. All countries should follow comprehensive and consistent national policies, even in the absence of international policy coordination. But to get the biggest bang for the buck and credibly escape the next significant negative shock, all three legs must stand together:  within countries; over time; and across countries.



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