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Governmental response

8 March 2021

The article at a glance

Fiscal measures totaling $14 trillion have proved effective in mitigating the pandemic’s economic effects including in emerging markets, says paper co-authored by Dr Kamiar Mohaddes of Cambridge Judge.

Fiscal measures totaling $14 trillion have proved effective in mitigating the pandemic’s economic effects including in emerging markets, says paper co-authored by Dr Kamiar Mohaddes of Cambridge Judge.

Kamiar Mohaddes.
Dr Kamiar Mohaddes

Fiscal policy measures taken around the world in response to COVID-19 (coronavirus) are playing a key role in mitigating the pandemic’s economic impact, with emerging markets also benefiting from the spillover effect and reduced financial market volatility, says a new paper co-authored at Cambridge Judge Business School.

Countries that implemented larger fiscal support are expected to experience less output contractions, other factors being equal, says the paper that looks at 33 countries (covering more than 90% of global GDP), which is part of a series of papers from the University of Cambridge and the Institute for New Economic Thinking.

“We showed that fiscal policy has been effective in preventing a more severe economic downturn across the world,” the paper concludes. “From a policy perspective, continued fiscal support to households and firms is necessary until vaccine rollout is advanced and the recovery is underway.”

Last week, the UK’s Chancellor of the Exchequer, Rishi Sunak, announced extension of a series of fiscal measures to prop up the economy, including a job furlough scheme and support for the self-employed.

The new paper – entitled “Covid-19 Fiscal Support and Its Effectiveness” – is co-authored by Alexander Chudik of the Federal Reserve Bank of Dallas, Kamiar Mohaddes of Cambridge Judge Business School, and Mehdi Raissi of the International Monetary Fund.

“The findings are significant because governments around the world are taking a close look at the effectiveness of fiscal steps taken so far in considering whether, when and how to reduce the fiscal measures they have already taken,” says co-author Kamiar Mohaddes, University Senior Lecturer in Economics & Policy at Cambridge Judge Business School.

“We conclude that continued fiscal support is still necessary at this time, pending a recovery that policymakers hope will follow effective vaccination programmes.”

Countries around the world offered fiscal support packages to save lives and protect households and businesses, with such packages estimated by the International Monetary Fund to reach nearly $14 trillion globally – $7.8 trillion in additional spending and foregone revenues, and $6 trillion in equity injections, loans and guarantees.

The paper uses a multi-country econometric model that is augmented with global volatility threshold variables to capture the effects of rare events such as COVID-19, and account for spillovers and interconnections of countries and markets (a “threshold-augmented global vector autoregression” model). It quantifies the macroeconomic effects of countries’ fiscal actions using a novel IMF-compiled database of discretionary government fiscal measures in response to COVID-19. The model takes into effect various factors such as global volatility, trade linkages and oil prices.

“This is crucial as the impact of shocks (and importantly that of COVID-19 and policy responses to mitigate its effects) cannot be reduced to a single country but rather involves multiple regions/countries, and this impact may be amplified or dampened depending on countries’ economic structures,” says the paper.

Looking at Quarter 2 (Q2) of 2020, the paper estimates that the effect of fiscal measures was particularly large in the US, Germany and Canada, at 7.1, 7, and 6.2 percentage points, respectively, followed by Japan and the euro area at around 4.5 percentage points.

While developing countries offered smaller fiscal packages, the paper found that measures taken in advanced economies had a “sizable and magnified” effect on such emerging markets due to policy spillovers and reduced volatility in global markets. At a global level, the study estimates that fiscal actions and their spillovers are estimated to have mitigated the collapse in quarter-on-quarter global growth by 2.7 to 2.8 percentage points between Q2 and Q3 of 2020. In advanced economies, quarter-on-quarter GDP growth was 4.9 percentage points higher in the second quarter of 2020 and two percentage points higher in the third quarter than it would have been without fiscal measures, the paper says.