IMF deputy chief wants governments to get fiscal houses in order as high interest rates loom

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When we last spoke with Gita Gopinath 21 months ago, the prominent economist and rising star at the International Monetary Fund was pondering how central banks would manage the rising tide of inflation.

Now, she’s urging governments to clean up their fiscal houses to manage the rising tide of central bank interest rates.

In an exclusive interview, the IMF’s No. 2 official cautioned that public finances face onerous increases in debt-servicing costs – a consequence of both the large expansion of government debt to fund support programs and stimulus spending during the COVID-19 pandemic, and the steep interest-rate increases from central banks aimed at snuffing out inflation.

With monetary policy trying to slow surprisingly resilient demand, employment and core inflation in many of the world’s economies, governments need to seize the opportunity to pull in the reins on spending while they can – to help ease off the economic throttle and to give themselves some much-needed fiscal breathing room.

“Given that countries need to rebuild fiscal buffers, and given that we’re in an environment where there’s a fight to bring inflation down … it would be helpful for fiscal policy to be tight,” Ms. Gopinath argued.

Ms. Gopinath’s comments were timely: Our interview came just hours before Fitch Ratings cut its credit rating for the United States government to AA-plus from its top rating of AAA. Fitch cited the U.S.’s “high and growing” public debt and an “expected fiscal deterioration over the next three years” as key reasons for the downgrade. Most damning, though, was what Fitch called “a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters.”

Economists and market strategists weren’t quite sure how concerned to be about the downgrade. After all, Fitch is not as important a credit-rater as Standard and Poor’s or Moody’s, and S&P has maintained an AA-plus rating on the United States since the waning days of the global financial crisis, more than a decade ago. Despite that long-standing downgrade from the top rating standard, U.S. bonds and currency have remained pretty much their bulletproof selves in global financial markets, and successive U.S. administrations and Congresses have had no trouble heaping onto the debt with little concern.

Nevertheless, the rating decision is a wake-up call. If U.S. government debt can be viewed as less stable and reliable following the costly pandemic, it suggests that debts with governments everywhere have emerged from the pandemic on shakier ground. And that policy-makers ignore this deteriorated condition at their own peril.

“If you look at the advanced economy group, our projection is for debt-servicing costs to rise. If you look at measures like debt servicing as a share of revenues, that is projected to go up. Now, that’s for a couple of reasons. One is because debt levels are projected to continue to grow. But also because interest rates are now higher,” Ms. Gopinath said.

“The question of how big a problem this is, in terms of at least the interest rate part, depends upon where we think interest rates will finally settle after we go through this period of high interest rates to bring inflation down.”

The IMF’s research has suggested that “there is a strong likelihood” that global interest rates could eventually retreat to something approaching prepandemic norms – “in which case, of course, that problem is not as big a deal in the long run. But that said, there’s lots of uncertainty surrounding that estimate.”

She warned that rising levels of government borrowing and debt “can cause those interest rates to be permanently higher,” complicating fiscal sustainability over the longer run. And looking down the road, climate investment and aging populations look poised to place rising spending demands on many advanced-economy governments.

“That part of spending puts debt on a rising trajectory. And that is what is problematic.”

Ms. Gopinath spoke from her home in Boston, the city where she worked as a Harvard University economics professor before becoming the IMF’s chief economist at the beginning of 2019. Early last year, she was promoted to first deputy managing director, putting her second in command at the global financial institution, under managing director Kristalina Georgieva.

“The role of FDMD has been an exhilarating experience. It has meant, relative to my prior role, lots more country engagement and diplomacy on the international stage,” Ms. Gopinath said.

IMF warns central banks of ‘uncomfortable truth’ in inflation fight

Just last week, the IMF published its new economic analysis and policy recommendations for Canada – something it does periodically for each of its 190 member countries. In that report, the IMF recommended, among other things, that Ottawa adopt a “a quantitative fiscal framework, including a specific debt anchor,” to instill greater discipline in federal budgets.

“To be able to build back buffers, it is very helpful to have a medium-term fiscal framework, and to have fiscal anchors – that’s what our research has found,” Mr. Gopinath said.

And she suggested that Ottawa’s approach to date – stating that it wants to reduce the deficit and the debt-to-GDP ratio over time, without specifying numerical targets – isn’t good enough.

“What your targets are – whether it’s debt-to-GDP or it is debt-servicing-costs-to-GDP – you want to take into account the environment, in terms of where interest rates are, and therefore how much space you have to run deficits. Being more quantitative in this kind of work can be very helpful.”