Box I.1 The interplay of fiscal and monetary policy (continued) Although the use of an expanded set of monetary policy tools has been beneficial to the COVID-19 crisis response, it has also increasingly blurred the lines between fiscal and monetary policy and raised the specter of governments trying to influence central banks to accommodate their fiscal needs. In this situation, referred to as “fiscal dominance,” the central bank sacrifices price stability to support the government’s fiscal policy goals. In the past, this practice has led to episodes of high or hyperinflation, which place a disproportionate burden on the poor and pose a significant obstacle to sustained economic growth in many emerging economies and efforts to tackle climate change and inequality. The greater interdependence between fiscal and monetary policy foreshadowed by the increased use of new monetary policy tools will
require improved coordination between fiscal and monetary authorities, as well as safeguards for central bank independence. In response to these emerging challenges, some emerging economies have introduced rules aimed at isolating central banks from political pressure to finance government outside of emergency situations. In Indonesia, for example, the central bank was prohibited from buying government bonds in the primary market. This prohibition was suspended through emergency legislation but only for a limited time (the prohibition on government financing must be reinstated by law in 2023). However, such rules are not always time-consistent, and it remains to be seen whether they can help countries strike the right balance between enabling an effective policy mix and safeguarding central bank independence.
a. Fratto et al. (2021).
Overall, the swift and decisive policy response to the COVID-19 crisis has mitigated its worst economic impacts in the short run. However, some crisis response measures have also given rise to new risks that may pose an obstacle to an equitable recovery in the longer term. Among these, the most pressing concerns are dramatically increased levels of public and private debt, as well as the significant risk of hidden debts and financial fragilities that will materialize once support and forbearance programs are scaled back. As the immediate effects of the pandemic subside, policy makers face the difficult task of striking the right balance between providing enough support to contain the worst human costs of the crisis, while limiting the longer-term risks that may arise from the crisis response. Given this context, chapter 1 of this Report highlights the mutually reinforcing links between the various sectors of the economy—households, firms, financial institutions, and governments—through which risks in one sector can affect the economy as a whole, and charts policies that can effectively reduce these risks and support an equitable recovery.
Notes 1.
2.
Global real GDP growth in 2020 is estimated at –3.1 percent in the International Monetary Fund’s World Economic Outlook (IMF 2021b) and –3.5 percent in the World Bank’s Global Economic Prospects (World Bank 2021a). See World Bank (2011). Also see Reinhart (2020). Although the COVID-19 pandemic evokes a comparison to the 1918 Spanish influenza pandemic, global
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3. 4.
economic conditions in the two periods are not comparable because of the wartime production under way during World War I as well as the stark differences in health and economic policy responses (Arthi and Parman 2021). Bordo and Meissner (2016); Reinhart and Rogoff (2009). Apedo-Amah et al. (2020).
