Transcript Recommendations

Lessons from Previous
Experience
 The current crisis represents a rare event, and
caution is needed when applying the lessons from
past experience to the present situation.
 Nevertheless, previous experience suggests that the
following issues should be considered carefully
when designing potential fiscal responses by
developing countries to the current crisis.
Recommendations
 Any fiscal response should be commensurate
to the shock experienced by the country.
 The effect of growth slowdowns in rich countries on
developing economies differs considerably across
countries, depending on the strength of their links with
rich countries through trade, capital flows, and
remittances.
 Past experience suggests that the adverse effects of
growth slowdowns in rich countries have been modest
for many developing countries.
Recommendations
 Consideration needs to be given to the scope for
monetary as well as fiscal policy responses, as both
entail risks.
 Policymakers need to consider the scope for coordinated
monetary and fiscal interventions, given the uncertain effects of
the latter.
 In many developing countries the central bank’s policy interest
rates are still high and inflation is modest, suggesting that there
may be scope for traditional easing measures.
However, Monetary response entails risks, including:
(i) downward pressures on exchange rates.
(ii) a loss of hard-won anti-inflationary credibility in countries
with past histories of reckless monetary policy and
accompanying high inflation.
Recommendations
 Fiscal expansions need to be credibly and sustainably
financed.
 Lack of access to external finance has been an important
impediment to expansionary fiscal policy during
downturns in developing countries. This problem is likely
to be acute during the crisis, with its accompanying
paralysis in international credit markets.
 Many developing countries have limited capacity for
domestic borrowing to finance increased spending, and
monetizing fiscal deficits is potentially very risky.
Recommendations
 Moreover, a fiscal expansion with weak investor
confidence in the sustainability of public finances
can be self-defeating.
 All this suggests that only those developing
countries with strong fiscal positions and large
reserve stocks can afford to finance a fiscal
expansion.
Recommendations
 The fiscal expansion must be timely but not rushed.
 Fiscal interventions need to be timely in order to be
effective, and that mistimed interventions can be
counter-productive.
 This has been a challenge in developed countries, and is
even more so in developing countries, where data quality
(to identify downturns and recoveries in real time) and
fiscal institutions (to design and implement any proposed
spending increases) are weak.
Recommendations
 There are serious risks to rushing ahead to expand
public spending when adequate oversight institutions
and capacity to appraise new projects are not in place –
as is the case in many developing countries.
 Policymakers should first carefully consider the scope
for expanding tested and well-functioning existing
projects and financing pre-appraised and 'shovel-ready'
new projects before embarking on completely new
and untried public spending projects.
Recommendations
 The balance of tax cuts versus spending increases
needs to be tailored to country circumstances.
 Assuming that there is a role for discretionary
expansionary fiscal policy that can be sustainably
financed, conventional wisdom is that spending increases
are more effective at stimulating aggregate demand,
since households might simply save tax cuts or direct
transfers. However, this tradeoff is complicated by two
factors in many developing countries.
Recommendations
1- On the one hand, in countries with weak fiscal and
oversight institutions the risk is greater that large new
public spending programs will be wasteful, captured,
and hard to reverse.
2- On the other hand, tax cuts and/or social insurance
transfers will not reach many of the poorest
households and firms in the informal sector. In fact,
there is a risk that such biased automatic stabilizers
might aggravate inequality during the downturn.
Recommendations
 To prevent a weakening of public finances, spending
increases should concentrate on areas where the
expenditures are either reversible or likely to increase
growth in the future.
 This is crucial to ensure that long-run fiscal and debt
sustainability is not jeopardized by the countercyclical
spending increase.
 Concretely, this can be done by focusing spending on
projects that act as automatic stabilizers. For example,
expansion of social benefit programs will naturally occur and
should be financed during downturn and will reverse as the
economy recovers.
Recommendations
 Similarly, workfare programs with a clearly below-market wage
offer will attract participants in downturns but will not be
appealing once the economy recovers.
 The risks of unsustainable public debt accumulation are also
reduced to the extent that increases in spending fall in areas
such as infrastructure, where there are reasonably
expectations of longer-term growth benefits as well as
direct cost-recovery through future user fees.
 Moreover, aside from this long-run growth contribution,
infrastructure projects can also provide the basis for
employment programs that reach poor workers.
Conclusion
 Historical experience suggests that expansionary
fiscal policy has not been an effective tool for most
developing countries in responding to economic
downturns. But this does not mean that fiscal policy
can play no role in mitigating the effects of the
current crisis; rather, it implies that
recommendations for countercyclical fiscal
measures should take into account lessons from
past experience.
Conclusion
 Developing countries should consider two priorities in the
use of the limited scope they may have for expansionary
fiscal policy – to ensure that short-term crisis alleviation is
aligned with long-run development:
 First, strengthening social safety nets is key in order to
help the most vulnerable and those most affected by the
crisis to cope.
 Second, spending increases should concentrate in areas
such as infrastructure to contribute to growth in the long
term. However there are obvious risks to proceeding
quickly with new infrastructure spending, and expansions
in this area could best be used to finance "shovel-ready"
projects that have already been appraised and found
viable.