If we observe the effectiveness of the central banking system across the world today, it reflects the extent to which monetary policy and lower interest rates are limitedly able to address cyclical (or even structural) downturns. Whether it is the US Federal Reserve, the European Central Bank, or the Reserve Bank of India, lower costs of borrowing or easier credit requirements, introduced with other quantitative (or non-quantitative) measures, have had minimal effects so far in pumping sustainable cycles of investment-production for higher growth in recent years. This has significantly passed the buck on exploring and utilizing the role of fiscal policy tools through pro-active budgetary spends to boost demand, incentivize targeted lending, and pursue a pro-growth agenda.
For those aware of contemporary macroeconomics, including most Monetarists, there is a widespread agreement that a well-crafted and fine-tuned fiscal policy, especially in developing nations, can go a long way in filling a hole in investment-production- consumption processes, and address some of these Keynesian concerns over the short-medium to long term. However, in understanding the role (and impact) of fiscal measures, one often understates how deeply politicized fiscal policies have become in most developing (and even developed nations) today, and somewhere, fail to effectively substitute technocratic central banks, that are assumed to ensure short-term economic stabilization.
The nature of politicization may differ from one state to another. In electoral democracies, budgetary spends are often directed toward ‘populist’ schemes (closer to election year) knowing fully that the implementation or outcome of such spends may have little to do in driving growth or addressing more immediate concerns. A party in power may do so to create a winnable political narrative for electoral gains or for a certain kind of self-projection.
Far worse, in more autocratic, authoritarian states, fiscal spends are misdirected toward other overheads (say, military spending) -- rather than toward areas of human capital development (education, healthcare, affordable housing) -- which might have long-term (negative) ramifications for growth and development.
Also, fiscal policies today, at least in electoral democracies having a legislature, have not only become politicized due to involvement of multiple actors and vested interest groups, but also deeply polarized, with decisions (to pass budgets) being made by razor-thin margins. For example, in the United States, while Democrats may prefer a higher budget spend for social security, healthcare and other transfers, the Republicans may prefer the very opposite, cutting expenditure and offering tax-breaks to corporate classes. This results in attaching a lower credibility on the effectiveness of fiscal policies.
At the same time, polarized, political budgets make it extremely difficult to allow fiscal policies to take short- to long-term measures aligned to the economic (and not political) interests of a citizenry.
A vital question that emerges here is: How can polarized fiscal steps hurt a country? As some might argue that budgets, in the past too, have always been subject to intense political mediations and negotiations across decades by big democratic governments. And while that may be true, it is critical to understand (and analyse) the motives of such mediations (that is to what and whose end).
If the next global economic crisis is likely to surface from the explosion of a large debt overhang, it may require an even more proactive fiscal policy intervention by states to address both national and global response scenarios. In a crisis, an immediate response makes all the difference in pursuing corrective measures, and given the time-taking complications of fiscal policy responses, the burden of responsibility to act swiftly somehow falls directly on central banks (as seen in the history of most 20th century economic crises). This can no longer be the case.
Going forward, for states to understand the relative importance of fiscal policies, untying political ends and prioritizing on economic goals (in short to medium term) will be critical. One step to do so is by pursuing activist fiscal policies through greater clarity, transparency of motives and by installing certain “automatic stabilizers.”
As Kenneth Rogoff argues, fiscal policy interventions might need to institute some form of automatic stabilizers to address (or prevent) chronic crisis scenarios. In a country like India, currently facing a structural downturn, and to avoid a further slowing down of consumption demand, automatic stabilizers in the recent Union Budget could have helped. These could have taken the shape of: increasing unemployment insurance transfers (or a scheme like NREGA); or a basic income transfer to farmers and lower-income groups, and with a targeted focus of spending on the unorganized, informal and rural segment of the population -- the largest base of consuming (and even producing) class.
Unfortunately, the government, in complete denial of the slowdown (the Finance Minister’s Budget speech didn’t even mention or acknowledge a ‘slowdown’) failed to ensure this. Instead, what we saw was a reduction in budgetary allocations for some of the vital social sector schemes (including NREGA). Fiscal constraints, to some experts, might justify the cuts, but such cuts leading to austere conditions, or a further slowing down of the economy, may make the situation worse for large developing nations such as ours.
Activist fiscal policies have thus a critical role in not only crowding-in investment opportunities for long-term growth, but also have a vital role to play in ensuring short-term stabilization, by boosting demand. Automatic Stabilizers further need to be embedded in activating proactive fiscal policies to not only complement monetary policy measures but also allow a closer, and more swifter, inter-substitution of monetary and fiscal policies in addressing the macroeconomics of the present and future times.
(The writer is Director, Centre for New Economics Studies, Jindal School of International Affairs)
