Compass Money: Is Austerity Dead? The Financial Response to the Pandemic

Instead of traditional austerity measures, IMF Director Kristalina has advocated for more government spending to respond to the pandemic. (Flickr)

Last week marked the end of fiscal orthodoxy as financial institutions stressed the need for increased government intervention in response to the pandemic. This guidance stands in stark contrast to the austerity response to the global financial crisis a decade ago. 

During the annual International Monetary Fund (IMF) and World Bank conference last week, the IMF cautioned countries against prematurely removing fiscal stimulus while encouraging new U.S. stimulus. World Bank President David Malpass asked private creditors to provide more debt relief and for the G20 to extend its debt relief program to assist developing countries. Their agenda marks a policy reversal compared to that of the Great Recession of 2008, where the IMF warned countries that they needed to reduce spending. 

The traditional argument for austerity, widely used after the debt and inflation crises in the 1970s, is that wages and prices would naturally adjust downwards during a recession. And without an impending debt crisis, consumer and business confidence would increase, spurring economic growth.

However, IMF Director Kristalina Georgieva explains that such natural adjustment creates a “scarring impact on communities” because people lose their jobs, skills, and health services, which then erodes long-term productivity. She states that a more fiscally active government could help soften the transition and avoid the pain that comes with industry collapse. 

The IMF admits that it prematurely prescribed austerity during the 2008 financial crisis, and it has since revised its recommendations to encourage countries to invest in a full recovery before worrying about finances. 

The pain of austerity in the early 2010s is not the only reason for this shift. The low cost of borrowing also provides justification for more government spending. The IMF projects that the overall deficit in 2025 will be similar to the one forecasted before the pandemic due to lower interest rates, giving advanced economies like the U.S. the green light to spend themselves out of a recession instead of cutting spending. 

However, many developing countries lack access to those same capital markets. In response, the World Bank called on the G20 to extend its suspension of debt-service payment collections through the end of 2021.

Despite this shift in policy, Oxfam, the anti-poverty charity, accused the IMF of forcing 84 percent of countries in its lending programs to adopt tougher austerity measures during the pandemic. “These measures could leave millions of people without access to healthcare or income support while they search for work, and could thwart any hope of sustainable recovery,” argues Ana Arendar, Oxfam International’s Interim Executive Director.