The indications are loud and clear that the government’s fiscal targets would be missed. The fiscal deficit is variously being estimated to go up to 7 per cent of GDP, which is doubled the budgeted level. Growth assumptions would be belied as the economy is set to shrink, once again by between 4.5 per cent and 10 per cent by various bodies from credit rating agencies to banks and International Monetary Fund.

In the situation the important question is how to meet the essential government expenses. This assumes all the more significance as to fight the sheer downturn and loss of income for the poorest, the government has already committed itself to large income support schemes and outlays.

The most obvious escape route suggested is to monetise the government debts. This is effect would mean the central bank funding the government through extending all the needed loans.

Raghuram Rajan, former governor of the Reserve Bank, has said that government meeting its expenses through borrowing from the central bank has its costs and cannot continue for long. There is a ring of truth in what he is saying, although pretty little could be done otherwise. Let us see what is behind Rajan’s caution.

What is happening currently is the Reserve Bank is buying government securities and expanding its own balance sheet. This could be done without straining the system as commercial banks are placing their excess funds with the Reserve Bank at reverse repo rate, which is fairly low. RBI could use the extra liquidity and pick up government borrowings.

What Rajan is also admitting that most other emerging economies are doing likewise and thus creating a situation in which prices eventually will come under pressure. This could happen without much hiccups in their overall financial system now as the system has excess liquidity and there is little demand for additional funds.

In the wake of the current pandemic, Dr Rajan describes the situation as the global economy has been put into a sort of induced coma. But when the economy comes out of it, and demand for credit picks up, there will be trouble in adjusting to the new situation. It will be difficult to meet the additional demand for fuelling the reviving economy and bring about liquidity pressure.

Unless the additional credit is supplied at the time when recovery kicks off, the overall growth and rejuvenation would suffer. It is like government crowding out the rest of the players, unless the government bonds with the central bank could be off-loaded in step. That could spell disaster in the financial markets and for banks as well.

The prognostications of financial economists like Dr Rajan sound out caution for the future. However, it is difficult to think of other options in the current situation of keeping the hibernating economies still breathing. To stick to the purist principles of balanced budget by governments and inflation targeting by the central banks could aggravate the situation.

These are not normal times. One has to take into account the situation created by the pandemic and absolute shrinkage in the economies of all countries. There is a dearth of demand, thereby a build up of liquidity. Banks have noted a rise in deposits.

As people curb their expenditure and save rather than consume overall demand is going southwards. Additionally, the large scale imposition of lock-downs and restrictions on travel to congregation of people has severely affected all sectors of economy. Manufacturing has slumped as factories, employing large number of people under one roof, are all shut. Thus the real economy has shrunk globally.

Economists all over the world are thinking of ways of getting out of the situation. How best to kick start economies, without creating too much disruptions. There are worries. Forced stoppage of activities would have inflicted huge financial damage. This is more true of the emerging market economies and their financial systems are facing threats of burgeoning burdens of bad debts. Their cumulative impact would be something to reckon.

In the circumstances, ff anything, the impact of the pandemic has induced a change in macroeconomic thinking.

Already a body of thinking had emerged which came to be known as “modern monetary theory” which advocated a new line of policy. Larger deficit created additional resources and thus worked as incentives for growth. Therefore, do not mind the size of the budget deficit too much only try to keep and preserve the pace of the economy.

By seeking to fund current expenditure when a pandemic has battered the economy and government’s take from the economy by way of taxes have plummeted, we have been following somewhat willy nilly the prescriptions of MMT. The pandemic has been a too sudden and devastating an episode and there is plenty of radical thinking on alternative economic models.

Already the established models of monetary theory were failing to provide adequate answers to all the issues of managing the troubled economies. The pandemic is now egging on the theorists to offer a new model for macroeconomics.

But for the time being, it is hard nosed practical sense that is driving economic management for survival in the face of the devastating pandemic. (IPA Service)