Getting fiscal policy in shape to swing with monetary policy

Since the outbreak and global spread of COVID-19, central banks and governments worldwide have provided massive support to the economy. The interaction between both has proven successful so far, but with monetary policy space likely to remain constrained by the lower bound on interest rates and high and rising government debt in some countries, the question is whether monetary and fiscal policy are in good enough shape to keep on swinging.

This article explores different options that could be pursued to rebuild fiscal policy space.

Will governments have to return to fiscal consolidation and structural reforms once the economic recovery is well underway, or will debt-to-GDP ratios automatically evaporate thanks to favourable financing conditions, rising economic activity, or higher inflation? The paper examines these questions by making use of government debt simulations for Belgium.

Alternatively, can central banks do the trick by simply cancelling the government bonds on the central bank balance sheets or would this be a risky undertaking? In the paper, simplified balance sheets are used to illustrate important insights.