Rethinking Fiscal Policy and Debt for a Post-Pandemic World

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The pandemic COVID-19 did what no war or financial crisis had in recent history. It made the governments of the world spend money concurrently. Lockdowns closed businesses. Supply chains broke. Millions lost jobs. In order to avoid complete economic devastation, governments borrowed and spent to unprecedented levels. Today, decades later, the world suffers the repercussions. Debt is higher. Inflation has been persistent. Interest rates are up. Knowing the effects of fiscal policy in this new reality is important to everyone who owns a business and is a citizen.

This course will discuss what is meant by fiscal policy and why it is important.

Fiscal policy is nothing more than the use of spending and taxes to shape the economy. If the economy is not doing well enough, governments can spend more or tax cuts to boost spending in their citizens' pockets. If the economy is heating up, governments can cut spending or cut taxes to dampen the heating.

In the pandemic, all governments opted for the first choice. They spent massively. They cut taxes. They dispensed direct aid to citizens. They subsidised wages. They delayed their repayments on the loan. This expenditure was in saving lives and livelihoods. It was, however, at a price. Governments had to borrow the money and that borrowing is what led to today's debt problems.

The Debt Hangover

The pandemic has left global debt in record amounts. The International Monetary Fund (IMF) estimated that the total amount of global debt was more than three hundred trillion dollars. The amounts of loans borrowed were very large in advanced economies, but also in developing countries. For many African countries, the pandemic loans were on top of already high levels of debt.

The problem is the high debt and not the debt. It's the price of the repayment. Governments need to have more funds for interest payments than resources for roads, schools and hospitals. When interest rates are down, debt doesn't bite. High interest rates make debt difficult to survive.

Now many countries are spending more on interest payment than their healthcare or education expenditure. The situation is not viable. Ultimately, a government will have to increase taxes, cut spending, or restructure its debts. None of these options are popular.

The Surge in Inflation and the Causes of the Surge in Inflation.

Following the pandemic, inflation has dramatically increased globally. The prices increased at a higher rate than in decades. Nigeria also saw inflation levels not seen in years. In the US and Europe, inflation reached 40 year highs.

What caused this? A series of factors conspired. To start with, pandemic government spending increased people's pockets. Secondly, supply chains were disrupted. The factories were unable to make enough products. There was a lack of speed on ships to move containers. Third, Ukraine's invasion led to further increases in the prices of food and energy products. Demand was high. Supply was low. Prices rose.

The central banks at first indicated that inflation would be short-lived. They were wrong. When they took action, inflation had already become entrenched in the economy.

Central Banks reacted with an increase in rates.

The primary weapon in the central bank's arsenal for combating inflation is interest rates. Raising interest rates by a central bank makes borrowing more costly. Businesses borrow less. Consumers borrow less. Spending slows. There is a slowdown in the rates of rise in prices when spending slows down.

The central banks of all countries have raised the interest rates drastically after the pandemic. The Fed increased the federal funds rate from almost zero to more than five percent. The European Central Bank trailed. The Central Bank of Nigeria (CBN) hiked its Monetary Policy Rate (MPR) several times to more than twenty-five percent.

There are the consequences of higher interest rates. Loans end up costing businesses a lot of money. Plans for expansion are put on hold. Mortgages and Car loans are more expensive for individuals. If governments have to service old debt, it is more costly because the interest rate for new debt will be higher.

The Challenge for Developing Countries

The interest rates caused a particular issue for developing countries. An increase in interest rates by the United States attracts global investors to invest in the United States instead of other developing countries. They can take advantage of higher returns with lower risk involved. This capital outflow has the effect of depressing local currencies. A depreciating currency further increases inflation as imports are more costly.

Nigeria was a victim of this. The naira came under pressure when foreign investors withdrew their funds. The Central Bank had to increase rates to bring back investments or else, the higher rates would impact local businesses. This balancing act is very challenging.

Fiscal Policy Options Now

What can governments do, with high debt and entrenched inflation? There are a number of choices available, but none is ideal.

The first thing is that governments can reduce expenditures. Cutting spending would decrease demand and aid in controlling the rate of inflation. It also lowers the necessity of taking on new loans. However, it is a political challenge to reduce spending. Citizens expect services. Trimming health care, education or infrastructure is unpopular.

Second, Governments can increase taxes. Increase in taxes takes money out of the economy, which helps deflate inflation. In addition to revenue, tax increases are one way that can help pay off debt. But like spending cuts, tax increases are unpopular. They also face the danger of slowing down the economic growth.

Thirdly, governments can attempt to expand their way out. If an economy grows faster than its debt, the debt is less than the size of the economy. It will take policies that promote investment, productivity and innovation. It's best, but it's the most difficult to do fast.

Fourth, governments have the option of restructuring their debt. Talking with creditors to make payments more manageable or make lower payments over a longer period of time can ease cash flow. In recent years, many African countries have implemented debt restructuring. It's hard but sometimes it's unavoidable.

What does this mean for everyday people?

It all seems like eating dirt, but it is a reality of everyday life. Governments that waste more on interest payments have less for schools, roads and hospitals. Loans for homes, cars, and businesses are costly when the interest rates are high. High inflation leads to lower value of money saved, and lower buying power of wages.

The world of work is challenging to young people. The high cost of borrowing hinders job creation. It is more expensive to borrow capital for starting a business. Normal day-to-day costs such as food and transportation take a bigger bite out of income.

The pressures are the same for business owners. Loans increase as operations expand and they are now more expensive. The purchasing power of customers is reduced. Margins are compressed on either side.