Daily Times

Rapid technological advancements, incessant globalisation and ceaseless market forces had already made economic policy making a difficult task and then along came COVID-19 to put a further spanner in the works.

Generally economic policy is an overarching vision for two underlying and crucial policies; i.e. monetary policy and fiscal policy. While both have different activities and controls to be used, their aim is the same – to boost aggregate demand! Nevertheless, in the last year and a half, economic policy has been in firefighting mode.

Monetary policy falls within the ambit of central banks and highlights actions needed to influence the quantity of money and credit in the economy. To do this, and contrary to popular opinion, central banks only have a couple of high level levers to execute its policy. One, cut interest rates to make borrowing cheaper. Two, buy financial instruments to increase the money supply – something which is termed quantitative easing. In contrast, fiscal policy is down to the government of the day and entails activities to collect and spend revenue; i.e. the fine balance between taxation and spending. Since the beginning of 2020, and in light of the gathering storms of the pandemic, monetary and fiscal policies have followed expected patterns. Interest rates were slashed to almost zero, more money was pumped into the system and spending was increased substantially. All in the hopes of stabilising and then increasing aggregate demand. But what about the future? Will the same trends continue in the next two to five year horizon? They can’t! Consider the following hypothesis.

Monetary policy will need to be gradually tightened by inching interest rates upwards so that too much easy credit is removed from the system, hence possibly eliminating the likelihood of an overheated economy down the road with its own unintended consequences

The biggest problems with a loose monetary policy – such in employment currently – is that if left unchecked, it can result in two aggrieved faces of the same coin. One, economic growth – though debt driven. Two, excessively high inflation because of so much easily available money circulating in the system. This in turn can sow the seeds of a deep financial crash in the near future. Under the influence of political stewardship, an expansionary monetary policy is well suited especially for a five-year election cycle! And this is exactly the reason why monetary policy was taken away from the politicians and given to the economists who could operate it without influence or prejudice.

Continuing in a similar vein, an expansionary fiscal policy – embarked upon by governments everywhere today – also has rather consequential drawbacks. The principal challenge is the spiralling government debt that is accrued! Simple logic dictates that if the spend is more than the collection then the gap will need to be completed by additional borrowing. And like any debt, it will have to be paid back by increasing collection at some later point and most likely via direct or indirect taxation. This can further lead to financial crowding out where the government squeezes out the private sector and creeps towards nationalisation of industry. Moreover, if the debt mountain becomes unsurmountable then a debt default becomes a real possibility and pushes up interest rate on government debt making it nearly impossible for the government to borrow anymore at any point in the future.

While the aforementioned economic policy maybe acceptable now, it will not be so in the near future and thus will need to be calibrated for the two to five year horizon ahead. Monetary policy will need to be gradually tightened by inching interest rates upwards so that too much easy credit is removed from the system hence possibly eliminating the likelihood of an overheated economy down the road with its own unintended consequences. This has happened in the recent past, as evidenced by the financial crisis of 2007 – 2008. In a recently published study in March 2021, EU corroborates this conclusion by suggesting, “monetary tightening may become necessary once the pandemic ends and the accumulated monetary overhang is unfrozen. Higher inflationary pressures can also be generated by other factors such as overshooting stimulus packages”. In the same report, the EU suggests this for fiscal policy, “governments and central banks should think ahead about how to avoid a policy trap caused by rapidly growing public debt and its de facto monetary financing, especially in the context of the potential return of inflationary pressures”. Meaning thereby that contractionary fiscal policy will need to be the approach of the future where government debt needs to be put back under control and private enterprises given centre stage as opposed to the government.

Is this doable? Yes but perhaps the most important aspect of this shift will be the timing of it. Do it too quickly and the good and necessary work done over the last year and a half by expansionary policy will go out the window! Do it too late and the writing will be on the wall in the form of a repeat of the 2007 – 2008 financial crisis! Change in policy is difficult at the best of times and these are certainly not the best of times! Nevertheless, that is exactly the reason that central banks and governments are given this responsibility. They have the experience, skill, acumen, and facts with them to make an informed choice about when expansionary policies will need to be swapped with contractionary approaches. If they can’t do that then they are no better than the mystics and fortune tellers sitting on sidewalks making chumps out of you and I.

The writer is Director Programmes for an international ICT organization based in the UK and writes on corporate strategy, socio-economic and geopolitical issues