The global economy is facing a unique situation due to unprecedented level of high inflation and that is causing tension between monetary and fiscal policies, IMF's Gita Gopinath said on Wednesday.
Speaking at a session during the World Economic Forum Annual Meeting 2023 in Davos, the first deputy managing director of the International Monetary Fund (IMF) said we have the kinds of inflation that we have never seen.
"It's coming down, but it's still high. That is what is generating the tension between monetary policy and fiscal policy..."
"You have an inflation problem to deal with, but you are still hit with shocks, like food shocks and energy shocks, that require fiscal policies to stand up. That is what is making the current conjuncture difficult," she noted.
"If you look at what happened to the public sector debt globally in 2020, it went up to around 99 per cent of GDP. Now it has come down to around 91 per cent of the GDP. That is because of a combination of the recovery and also because of inflation inflating away some of that debt."
On what needs to change, she said for the countries to manage such a difficult trade-off right, fiscal policy has to play a role.
"One, it should be consistent with bringing inflation down, which means, at the minimum, it should not be expansionary. The second thing that fiscal policy should keep in mind is that you need to protect the most vulnerable, and they need to do that again when it comes to food and energy. These are fundamental essentials for households. You need to provide support for that," she said.
"Lastly, it is essential to communicate a sound fiscal framework and clarity on bringing down debt," Gopinath said.
During the same session, Raghuram Rajan of the University of Chicago Booth School of Business said it needs to be seen why spending was so easy.
"Part of that is because the central banks had anaesthetised bonds. The problem is some of it was hidden. What central banks were doing is buying long-term debt and financing it with overnight money," said the former RBI Governor.
"When you put the balance sheet of the central bank together with the government balance sheet, what it means is governments have reduced the maturity of their debt," he said.
"So high-interest rates hit harder earlier in many countries. Of course, the other problem is the size of the debt has gone up tremendously over the last few years, and that is actually an interesting issue. Why has fiscal discipline broken down? Spending today is highly untargeted," he said.
