Navigating the global fiscal trilemma: Spend more, tax less, manage debt

It is within this fiscally tight macroeconomic context that governments have to navigate multiple competing priorities against an increasingly complicated backdrop. "Public debt and deficits are increasing to dangerous levels, global growth is slowing, and interest-rate trajectories remain uncertain," argues Vitor Gaspar, Director of the International Monetary Fund's (IMF) fiscal affairs department.

He detailed his views on the platform of "Foreign Policy". The current economic environment reminds him of the early part of the 1980s' economic chaos, especially in the aftermath of an intensive anti-inflation program.

But things are very different in the contemporary scenario. Conceding alongside these other variables are the mega-existing worldwide issues such as climate change an aging population and persisting challenges of poverty and inequality. This will only keep hounding the government kitty. Public demand for fiscal restraint has declined in the last two decades; populism has contributed to a weakened call for government financial discipline.

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The three challenges that governments globally need to deal with

This has created a fiscal policy trilemma. There are three conflicting pressures governments have to choose from. There are growing demands for increased spending on areas such as defense and climate action; they cannot increase taxes; and countries need to address the rising public debt and deficits threatening financial stability.

These three constraints are difficult to square. For instance, a government can choose to reduce its debt but refuse to introduce tax rises. Then it would have to slash public spending and in most cases, this is far from being a highly popular move. Ultimately, it results in social and political disruptions. It can spend more without raising taxes, further surging down the debt and deficits and thus threatening fiscal health. Even the most developed and developing economies are fighting this complex tug of war.

It is to be noted that, in the early 1980s, similar fiscal challenges were faced by emerging markets. Further, if things are not managed properly by the leading economies, then it can trigger another global debt crisis. This is the challenge policymakers are faced with; but how do they navigate this course without repeating history?

Over the 80 years of its existence, much has transformed in the IMF's world of international macroeconomics. From Keynesian principles calling for an interventionist regime in macroeconomics, the IMF has experienced many changes and shifts. Inflation sprees in the 1970s and early 1980s created a new challenge, focusing on the independence of monetary policy by inflation targeting, as in New Zealand since 1989.

Such is the nature of economic thought, and this has contributed to a change in policy around Europe to adopt monetary union frameworks. While fiscal policy continues, at least in structural areas concerning topics like inequality and growth, as central, it was no longer nearly the business cycle stabilizer of yesteryear. To successfully work under such pressures governments must operate within the framework of a fiscal policy and focus on resolving the current trilemma by taking proper steps.