How to pay for the stimulus

Context: Money financing is a viable route to take us back to pre-COVID-19 levels of output.

Issues with public spending:

• Greater public spending will increase the fiscal deficit and this expansion has to be financed.

• Theoretically, it can be financed by higher taxes.
• But when the economy is in a recession, this option cannot be explored even though the balanced-budget multiplier is one.

• When the multiplier is one, output expands by the same amount as the increase in government spending.

Issues related to borrowing from the World Bank and IMF:

• Paying back in hard currency: This would involve India having to earn hard currency by stepping up exports.

• If a stimulus of approximately 10% of the GDP is envisaged, with exports at 25% of the GDP, it would imply stepping up exports by close to 50%.
• This would be a herculean task under present circumstances.

• Issue of conditionalities: It is not obvious what conditionalities will come along with the loan.

• Delay in negotiation: The loan is bound to take some time to be negotiated, taxing the energies of a government that ought to be engaged in the day to day battle with COVID-19.
• The external debt is truly national which, arguably, government bonds held by the country’s private sector are not.

Way Forward: 

• Money financing: Economic argument against money financing is that it is inflationary.

• However, whether a fiscal expansion is inflationary or not is related more to the state of the economy than the medium of its financing.
• When resources are unemployed, the output may be expected to expand without inflation.

• We need to explore the option of money financing to take India back to pre-COVID-19 levels of output and employment.