Must-Read: Vitor Gaspar, Maurice Obstfeld, Ratna Sahay, et al.: Macroeconomic Management When Policy Space Is Constrained: A Comprehensive, Consistent, and Coordinated Approach to Economic Policy

Must-Read: Vitor Gaspar, Maurice Obstfeld, Ratna Sahay, et al.: Macroeconomic Management When Policy Space Is Constrained: A Comprehensive, Consistent, and Coordinated Approach to Economic Policy: “Global output remains below potential, unemployment above its natural rate, and inflation below target…

…Concern is widespread that countercyclical policies have run out of space or lack the power to raise growth or deal with the next negative shock. The common perceptions are that the effective lower bound on policy interest rates limits the room to loosen monetary conditions further and that high debt constrains fiscal policy, including automatic stabilizers….

This Staff Discussion Note argues that room exists for effective policies and that it should be used if appropriate… a comprehensive, consistent, and coordinated approach to policymaking….

Comprehensive policy… entails the mutually supportive use of the three policy prongs—monetary, fiscal, and structural—tailored to specific country circumstances…. Demand-management policies can support implementation of structural reforms that increase potential growth…. When monetary policy is constrained, fiscal policy provides support. Similarly, monetary policy accommodation prevents a crowding out of the expansionary fiscal response to a negative shock. Some countries have room for fiscal stimulus, especially in an environment of extremely low long-term interest rates. For others where room for fiscal maneuver is especially limited… better tailoring the pace of necessary fiscal adjustment and implementing growth-friendly fiscal rebalancing. Financial sector policies that strengthen banking systems and markets help improve the transmission of monetary policy and dampen shocks.

Consistent policy frameworks anchor long-term expectations while allowing decisive short- to medium-term accommodation whenever necessary. They do so by systematically linking instruments to policy objectives over time…. Monetary policy… allows effective stimulus, even when the policy interest rate is at its floor, in the form of a planned temporary overshoot of the inflation target. Fiscal policy must commit to managing public balance sheet risks…. Credible commitment and enduring practice of prudent management allow fiscal policy the flexibility to support economic activity when appropriate.

Finally, coordinated policies across major economies amplify the helpful effects of individual policy actions through positive cross-border spillovers…. Coordination of active monetary and fiscal policy adds particular value if the current policy approach falls short of reviving growth, or in the event of a further downward shock.