a world safe for spending

image: design from the IMF’s October 2023 Fiscal Monitor.

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October 6, 2023

Earlier this week, I scrolled past an IMF blogpost on balancing climate investments with debt sustainability. I feel like these kinds of arguments are a dime a dozen, considering how austerity-minded politicians and policymakers have historically weaponized debt as a boogeyman to resist any kind of ambitious policy that happens to require spending any money.

Normally, I’d continue about my day. But the blogpost―a preview of the first chapter of the IMF’s October 2023 Fiscal Monitor―featured this inane sentence that I couldn’t not share: “Governments thus face a policy trilemma between achieving climate goals, fiscal sustainability, and political feasibility. In other words, pursuing any two of these objectives comes at the cost of partially sacrificing the third.”

Calling things “trilemmas” is all the rage, I know. But taking the “fiscaI sustainability” pillar seriously relative to the other two is incoherent. Upon close reading, so are many of the piece’s other core arguments. In the hopes that I can help delineate how the economic theory here is at odds with how policymakers should be imagining the macroeconomy, I want to call some balls and strikes here.

The key argument is that greater spending will not generate greater growth:

Relying mostly on spending measures and scaling them up to deliver on climate ambitions will become increasingly costly, possibly raising debt by 45 percent to 50 percent of gross domestic product by midcentury. High debt, rising interest rates, and weaker growth prospects will further make public finances harder to balance.

This kind of macroeconomics is no fun because there’s no reason it needs to be true. I raise the usual protest, that greater public spending that drives investment and consumer demand allows governments to create growth that defangs any potential burdens from larger debt stocks. It’s odd that the IMF is so pessimistic that global growth will be so weak even under a world of increased spending―especially considering how well the United States has done for itself, from a growth standpoint, through its massive investment packages.

Yet the blogpost features this graph to make readers worry about such abstract aggregated quantities as the debt-to-GDP ratio:

There’s no doubt that debt is an issue, especially in emerging markets, but this piece does not justify why a 50% debt-to-GDP ratio, or any other ratio, for that matter, should be so worrying to policymakers, especially in comparison to climate catastrophe.

I am also wondering: how do governments “deliver on climate ambitions” without “relying mostly on spending measures”?

Unfortunately, the blogpost’s answer is mostly “carbon tax.” The blogpost assumes that a carbon tax necessarily forces the reallocation of capital toward investments in decarbonization. That’s stupid; a carbon tax will not do any of that absent demand to validate those investments. Without juicing investment and consumer demand to really force the reallocation of capital, you get carbon shock therapy.

The blogpost seems to briefly acknowledge that carbon pricing may not necessarily speed up the deployment of clean tech and renewable energy, and the Fiscal Monitor agrees that carbon pricing can hurt vulnerable groups. But carbon pricing remains their bedrock policy recommendation despite this.

(Sidebar: As per the IMF Fiscal Monitor’s own data, it doesn’t look like G20 countries with carbon pricing programs have seen substantially better emissions reductions than their peers have:

It really looks like the countries shooting past the G20 average are ones that don’t rely on a carbon price to drive decarbonization, with Canada the exception.)

I have more questions about the economic coherence of these arguments. The Fiscal Monitor judges that:

Expenditure measures will support output in the short term,
while higher public capital will add to the economies’ productive capacity, boosting long-term output. However, higher expenditures raise budget deficits and add to the pressures on interest rates and government borrowing costs by raising the demand for capital (macroeconomic channel) and increasing the supply of government debt (fiscal channel).

The first half is getting somewhere, insofar as it admits that spending now can buoy short-term and long-term output. (Hi, Keynes.) But it is irresponsible to take the second half for granted: the logic that higher spending necessarily raises government borrowing costs sits within a flawed “loanable funds” model of the economy that treats the availability of finance as a fixed quantity. That’s simply not a useful assumption in the global macroeconomic context.

To get a bit more into the weeds: Total decarbonization requires every government and private entity to undertake immense amounts of investment. These investments are less and less risky the more demand there is for what those investments produce. So long as that demand is there, regardless of whose demand it is, debt incurred to finance investment to meet that demand can remain liquid. Interest rates―alternatively, the price of liquidity―do not need to rise. (I am presently halfway through the General Theory and this is more or less how I understand what’s going on.)

The Monitor is right, however, that this is not the world emerging markets are in:

Many emerging market economies would find the increases in debt and deficits challenging, especially those already experiencing high debt, as rising borrowing costs lead to higher interest payments and
account for a sizable part of the deteriorating debt dynamics.

These are very real challenges. But the Fiscal Monitor buries their causes. At this point, rising global borrowing costs are a consequence of Federal Reserve interest rate hikes―not necessarily the result bad macroeconomic management in emerging markets themselves. Rather than acknowledge this truth and advocate for more responsible global economic governance, the Monitor supports “improving spending efficiency and mobilizing alternative sources of finance, including other domestic tax revenues … and a greater role for private financing.” Given the global macroeconomic barriers to mobilizing private finance, better domestic tax regimes and deeper domestic capital markets will only help emerging markets secure more fiscal headroom at the margins.

To summarize, the IMF’s thinking on fiscal policy seems to rest on three questionable foundations: (1) assuming weaker long-term growth despite even substantial investment in decarbonization, (2) assuming that a carbon tax and related carbon pricing policies reallocate investment toward decarbonization to the degree required, and (3) assuming that government spending necessarily raises borrowing costs. All three assumptions should not be taken for granted at the global or local level.

That’s not to say a Keynesian investment push will immediately deliver on its promises, however. Many institutions stand in the way, including the credit rating agencies, which have global reach to punish governments for undertaking socially and environmentally conscious spending plans, and institutional investors, whose notions of risk and reward prevent them from collaborating at scale with governments, and the Fed, which sets the global cost of investment, and other independent central banks, which cannot always provide liquidity to their countries’ economies. Both indirectly and directly, these institutions will thwart many countries from making a debt-financed push for decarbonization. Yet these are the very institutions whose stature the IMF usually protects.

The Fiscal Monitor is right that emerging markets have it hard. But its authors refuse to name all the reasons why. If the IMF really wanted to break the tradeoff between debt and climate, to make a public investment push synonymous with “prudent,” it would use its political leverage to address the real financing constraints governments face. Whether through SDRs or more forgiving structural adjustment policies or more balance of payments lending, it could use its power as one of the key gatekeepers of global liquidity to make the world safe for the sheer volume of public spending that the green transition requires.

A world safe for public spending is a world safe for growth, development, and decarbonization. The IMF might call this triptych a trilemma, too, as if policymakers can’t pursue all three at the same time. But we should know better than to imagine tradeoffs where they don’t need to exist. That’s austerity-brain.