IMF Warns Cutting Government Spending Too Soon Could Derail Recovery

As governments rushed out funding to prevent an economic collapse amid the coronavirus pandemic, global public debt swelled to the highest in history, but the IMF warned Friday that cutting back too soon could undermine the recovery.

Government spending "will need to remain supportive and flexible until a safe and durable exit from the crisis is secured," IMF fiscal policy chief Vitor Gaspar and chief economist Gita Gopinath said in a blog post.

Even with record low interest rates worldwide, the debt figures are staggering -- surpassing the size of the global economy, and deficits in advanced economies five times higher than pre-pandemic estimates for 2020.

The health crisis and the business shutdowns to contain the spread of COVID-19 demanded "a massive fiscal response" of close to $11 trillion to help support households and prevent bankruptcies," the authors said.

"But the policy response has also contributed to global public debt reaching its highest level in recorded history, at over 100 percent of global GDP, in excess of post-World War II peaks."

And, they cautioned, "we are not out of the woods."

The Washington-based crisis lender, which historically has always advocated for governments to restrain spending, is in the unusual position of urging officials to flood their countries with cash while also sounding the warning about pitfalls ahead, especially if cases rebound.

"While the trajectory of public debt could drift up further ... an earlier-than-warranted fiscal retrenchment presents an even greater risk of derailing the recovery, with larger future fiscal costs," they warned.

Profound Transformation

In the wake of the 2008 global financial crisis many governments shut down their stimulus programs at the first sign their economies had stabilized, which led to a slow, sluggish recovery.

Now the "need for continued fiscal support is clear," Gaspar and Gopinath wrote, but countries also will need to find a way to finance it without debt becoming unsustainable.

That includes improving tax collection, making taxes more progressive, so those with higher incomes pay more, and eliminating subsidies on fuel while adopting revenue measures such as carbon pricing.

In addition, in the face of "profound" transformations of their economies, governments should focus their efforts on sectors that will survive the crisis, rather than those that will shrink, such as air travel, including possibly nationalizing industries temporarily.

"Even as many countries tentatively exit the Great Lockdown, in the absence of a solution to the health crisis, huge uncertainties remain about the path of the recovery," they said.

"Many of the jobs destroyed by the crisis will likely not return."