The economic and financial crisis, policy responses and their impact on public finances. A global perspective

Enrique Alberola and Fernando Gutiérrez del Arroyo

Economic Bulletin, 2009, issue JUL, No 7, 159-178

Abstract: The worsening of the economic and financial situation since summer 2007 and, especially, its drastic intensification from September last year are having far-reaching consequences on the public finances of the main developed economies and, to a lesser degree, on those of developing countries. The deterioration of public finances reflects the strong economic policy response through fiscal stimulus plans and measures to support the financial system, though it also increasingly mirrors the severe decline in economic and financial activity. The economic policy response has involved not only the tax authorities but also central banks and other public entities – such as deposit guarantee funds and public and semi-public financial institutions. Chart 1 provides a simplified representation of the quickening and growing involvement of US authorities by quantifying the support provided by the Federal Reserve and the Treasury to the financial system as well as the fiscal stimulus measures. Between summer 2007 and March 2008, the effects of the financial turmoil on activity were still relatively moderate and their scope was limited to the United States and a growing number of developed economies. In that period, financial support was based, essentially, on increasing the liquidity provided by central banks and on occasional bail-outs of specific entities. Furthermore, an initial fiscal stimulus package was implemented in the United States in February 2008. From March 2008 (with the Bear Stearns bail-out), the deepening of the financial problems led to a stepping-up of support which remained centred on providing liquidity. In mid-September, however, there was a quantitative and qualitative leap in the economic policy response in all advanced economies and, to a lesser extent and slightly later, in emerging economies. On the one hand, the spectrum of financial support measures was extended significantly (to include, in addition to practically unlimited liquidity, direct financing of financial institutions and other sectors, capital injections, asset purchases and guarantees for bank assets and liabilities); and on the other, fiscal stimulus plans were introduced in an increasing number of countries. The amounts committed in the financial and economic sphere have multiplied since last summer. For example, in the United States – excluding guarantees – they have increased sixfold and already account for half of its gross domestic product (see Chart 1). All these measures are resulting in a sharp increase in government deficits and in public debt ratios and a strong deterioration in the long-term fiscal outlook. However, it is difficult a priori to assess the fiscal cost of the crisis. First, a substantial amount of committed government financial support has not yet been used or does not represent an actual upfront outlay (as in the case of guarantees) or, even if it does, it may be partially recovered a posteriori (as in the case of asset purchases or lending). Second, a large share of government support, undertaken by central banks or other financially independent bodies, falls, in principle, outside the scope of the budget; however, a portion of these amounts could ultimately have a potentially large budgetary impact. Third, the crisis is still ongoing, which makes it difficult not only to evaluate its fiscal impact but even to make an up-to-date calculation of the amounts invested. In this context, the purpose of this article is to assess from a quantitative, qualitative and comparative standpoint the channels through which the financial and economic crisis and the economic policy response to it are affecting public finances, adopting a global and, insofar as is possible, homogenous perspective, covering both advanced and emerging economies. To this end, it is necessary to establish a framework of analysis which makes it possible to differentiate, on the one hand, between the impact related to the financial crisis and that linked to the economic recession; and, on the other, between the direct impact of the crisis connected with the adjustment of economic and financial activity, and that arising from economic policy measures. In this framework, first, the financial sector support measures adopted by various economic authorities will be analysed in some detail, drawing a distinction between the various consequences that they may have on public finances at different time horizons. Second, the fiscal stimulus plans and the direct impact of the crisis on government revenue and expenditure, fiscal balances and government debt will be studied. Similarly, the medium-term impact on public finances and, especially, on the expected debt dynamic is examined. From the whole analysis, it is concluded that public finances will be in a delicate situation over the next few years. This deterioration poses notable challenges for economic authorities, including, inter alia, those of taking steps so that the fragile situation in itself does not limit the effectiveness of the measures adopted and reaffirming the long-term commitment to fiscal discipline.

Date: 2009
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