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The Global Pandemic, Policy Space and Fiscal Rules to Achieve Stronger Stabilization Policies

Cited 3 time in Web of Science Cited 4 time in Scopus

Michael M. Hutchison

Issue Date
Institute of Economic Research, Seoul National University
Seoul Journal of Economics, Vol.33 No.3, pp.307
PandemicFiscal rulesStabilization Policy
The world economy was slowing prior to the onset of the
Covid-19 pandemic. The slowdown began after a record-long period of expansion marked with record lows in unemployment and
strong economic indicators along most dimensions. Even at a high point of the business cycle, however, depression style economic policies of very low or zero policy interest rates and large budget deficits were being followed in many countries—partly due to the lingering effects of the Great Recession and partly due the longstanding problem of deficit bias in fiscal policy. Fiscal responses to the Covid-19 shock in the form of wage support, business loans and other programs in 2020 were substantial and necessary but,
following already large fiscal deficits and growing government debt, have aggravated the problem of long-term fiscal solvency. In some cases, concerns over record peacetime budget deficits constrained governments willingness to pursue further rounds of fiscal stimulus as the Covid-19 crisis deepened. This article argues that deficit bias constrained discretionary fiscal policy actions arises from political economy factors and demonstrates that fiscal rules are an important instrument to mitigate deficit bias and restore countries to longer-term solvency. Countries with strong fiscal rules had much better fiscal and debt positions prior to the Great Financial Crisis, allowing them in turn to pursue much more stimulative
fiscal policies in response to the crisis. The same situation faced policy makers at the onset of the pandemic economic crisis-- those with strong fiscal rules were in a much better position to provide large fiscal responses to support the economy without endangering national debt solvency. Facilitating long-term fiscal solvency and allowing for larger discretionary fiscal actions in crisis situations provides a strong argument for the strengthening and enforcement of fiscal rules around the world.
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